Receivables and Revenues: Comprehensive Study Guide

Recognition of Accounts Receivable and Revenue

• Credit Sales and Accounts Receivable Fundamentals:

  • Credit sales occur whenever an enterprise provides goods or services to customers on account rather than receiving immediate cash payment.
  • At the time of a credit sale, two core financial components are recognized simultaneously:
  • Accounts Receivable: An asset account reflecting legal claims against customers for cash owed from the delivery of goods or services on account.
  • Revenue: Recognized immediately upon transferring goods or services to the customer, provided that future cash collection is probable, in accordance with accrual accounting principles.

• Accounting Entries for Credit Transactions:

  • Initial Sale on Account:
  • When services are delivered on credit (e.g., providing $\$500$ of services on March 1 with payment due March 31):
    • Debit: Accounts Receivable for $\$500$
    • Credit: Service Revenue for $\$500$
  • Subsequent Cash Collection:
  • When the receivable is settled by the customer on March 31:
    • Debit: Cash for $\$500$
    • Credit: Accounts Receivable for $\$500$

• Economic Trade-Offs of Credit Policies:

  • Benefits: Offering credit facilitates purchasing for buyers, enhancing customer acquisition, sales volume, and long-term firm profitability.
  • Costs: Delayed cash inflows impair operational cash flow; extended non-payment or default risks reduce operating efficiency and net earnings.

• Classification of Receivables:

  • Trade Receivables: Accounts receivable arising directly from sales of goods or services to primary customers.
  • Nontrade Receivables: Claims originating from non-operating transactions, including income tax refund claims, interest receivable, and loans extended by the firm to officers, stockholders, or employees.
  • Notes Receivable: Formal debt contracts documented by written promissory notes bearing stated interest and specific maturity schedules.

Measurement of Net Revenues: Discounts, Returns, and Allowances

• Net Revenue Concept:

  • Gross revenue represents the total list price or billed value of goods and services.
  • Net revenue reflects the net consideration the firm actually expects to receive:     $\text{Net Revenues} = \text{Total Gross Revenues} - \text{Sales Returns} - \text{Sales Allowances} - \text{Sales Discounts}$

• Trade Discounts:

  • Reductions below published list prices offered to incentivize large-volume buyers, preferred consumer groups, or off-season transactions.
  • Accounting Treatment: Trade discounts are not recorded in separate general ledger accounts; the sale and accounts receivable are recorded net of the trade discount directly.
  • Worked Example: A firm typically prices laser eye surgery at $\$3,000$, but offers a promotional price in March of $\$2,400$ ($\$600$ trade discount):
  • Debit: Accounts Receivable for $\$2,400$
  • Credit: Service Revenue for $\$2,400$

• Sales Returns:
  • Occur when a customer physically returns purchased merchandise.
  • Remedy: If original purchase was cash, the seller issues a cash refund; if original purchase was on credit, the seller credits (reduces) Accounts Receivable.
  • Worked Example: On March 2, merchandise is sold for $\$200$ on account; on March 4, the buyer returns the merchandise for full credit:
  • Debit: Sales Returns for $\$200$
  • Credit: Accounts Receivable for $\$200$

• Sales Allowances:
  • Occur when a customer retains deficient or damaged merchandise, or experiences unsatisfactory service, and the seller agrees to reduce the transaction price.
  • Remedy: Cash refund or reduction of the customer\'s accounts receivable balance.
  • Worked Example: A patient dissatisfied with laser eye surgery billed at $\$2,400$ on March 1 receives a $\$400$ price reduction on March 5:
  • Debit: Sales Allowances for $\$400$
  • Credit: Accounts Receivable for $\$400$

• Nature of Contra Revenue Accounts:

  • Sales Returns and Sales Allowances are contra revenue accounts with normal debit balances.
  • While they reduce reported net income like expenses, contra revenues represent direct deductions from gross revenues rather than the costs incurred to generate revenues.

• Sales Discounts (Cash Discounts):

  • Incentives for prompt cash settlement of credit invoices within a specified period.
  • Expressed as credit terms such as $2/10,\,n/30$:
  • $2/10$: A $2\%$ discount is granted if payment occurs within $10$ days of invoice date.
  • $n/30$: The net invoice balance is due in full within $30$ days if discount is foregone.
  • Collection Within Discount Window:
  • Continuing the laser eye surgery example ($\$2,400$ initial billing less $\$400$ allowance leaves a $\$2,000$ receivable balance). If paid on March 10 within the 10-day window, a $2\%$ discount (\2,000 \times 2\% = \$40$) is applied:
    • Debit: Cash for $\$1,960$
    • Debit: Sales Discounts for $\$40$
    • Credit: Accounts Receivable for $\$2,000$
  • Collection Outside Discount Window:
  • If payment occurs on March 31 after the 10-day period expires:
    • Debit: Cash for $\$2,000$
    • Credit: Accounts Receivable for $\$2,000$

• Year-End Adjusting Requirements for Contra Revenues:
  • Revenue recognition standards mandate that companies report revenues representing the amount of consideration expected to be received.
  • In addition to recognizing returns, allowances, and discounts as they occur during the fiscal period, firms must prepare year-end adjusting entries to estimate future returns, allowances, and discounts pertaining to current-period sales.

The Allowance Method for Estimating Uncollectible Accounts

• Uncollectible Accounts (Doubtful Accounts):

  • Accounts receivable balances that customers will ultimately fail to pay due to financial distress or dispute.

• Mandate of the Allowance Method (GAAP):

  • Financial accounting standards mandate the allowance method for financial reporting.
  • Requires estimating future uncollectible accounts in the period credit sales occur.
  • Matches Bad Debt Expense with associated revenues in the current income statement while reporting receivables at net realizable value on the balance sheet.
  • Key Operating Framework:
  • Year-end year 1: Estimate uncollectible amounts and record Bad Debt Expense alongside Allowance for Uncollectible Accounts.
  • Subsequent year: Write off actual bad debts against the allowance when individual defaults occur.
  • Year-end subsequent year: Re-estimate uncollectible accounts and adjust the allowance.

• Recording Initial Allowance (Kimzey Medical Supply Example - 2027):

  • Credit sales for 2027 total $\$50\text{ million}$; uncollected accounts receivable at December 31, 2027 equal $\$20\text{ million}$.
  • Estimated default rate equals $30\%$ of outstanding receivables:     \text{Estimated Uncollectible} = \20\text{ million} \times 30\% = \$6\text{ million}$
  • Adjusting Entry (December 31, 2027):
  • Debit: Bad Debt Expense for $\$6\text{ million}$
  • Credit: Allowance for Uncollectible Accounts for $\$6\text{ million}$

• Balance Sheet and Income Statement Reporting:
  • Allowance for Uncollectible Accounts: A contra asset account paired directly with Accounts Receivable.
  • Carrying value (Net Accounts Receivable):     $\text{Net Accounts Receivable} = \text{Accounts Receivable} - \text{Allowance for Uncollectible Accounts}$     \text{Net Accounts Receivable} = \20\text{ million} - \$6\text{ million} = \$14\text{ million}$
  • Common Classification Error: The Allowance account carries a normal credit balance, but it is not a liability. It represents a valuation reduction of an asset.

Writing Off and Recovering Uncollectible Accounts

• The Write-Off Process:
  • When an individual customer account is determined uncollectible, the specific balance is removed from the accounting records.
  • Journal Entry (February 23, 2028 - Kimzey writes off a former patient\'s $\$4,000$ account):
  • Debit: Allowance for Uncollectible Accounts for $\$4,000$
  • Credit: Accounts Receivable for $\$4,000$

• Financial Statement Neutrality of Write-Offs:

  • Writing off an account reduces both gross Accounts Receivable and Allowance for Uncollectible Accounts by identical amounts.
  • The write-off has zero effect on total assets, net accounts receivable, expenses, or net income:
  • Pre-write-off: $\$20,000,000 - \$6,000,000 = \$14,000,000$
  • Post-write-off: $\$19,996,000 - \$5,996,000 = \$14,000,000$
  • Common Error: Recording Bad Debt Expense at the time of write-off is incorrect; the expense was already recognized during the prior period adjusting entry.

• Recovery of Accounts Previously Written Off:

  • When payment is unexpectedly received from an account previously written off (e.g., September 8, 2028 collection of $\$1,000$ by Kimzey), a two-step procedure is required:
  1. Re-establish the Receivable:
     • Debit: Accounts Receivable for $\$1,000$
     • Credit: Allowance for Uncollectible Accounts for $\$1,000$
  2. Record the Cash Collection:
     • Debit: Cash for $\$1,000$
     • Credit: Accounts Receivable for $\$1,000$

Subsequent Year Adjustments: Aging Schedule and Balance Sheet Approach

• Percentage-of-Receivables Method:

  • A balance sheet approach estimating uncollectible accounts as a percentage of total outstanding ending accounts receivable.
  • Percentages reflect historical recovery trends, macroeconomic conditions, and industry defaults.

• The Aging Method Mechanics:

  • Stratifies customer receivables into chronological aging categories based on days past due.
  • Reflects the empirical accounting principle that the longer an account is overdue, the less likely it is to be collected.
  • Provides a more precise valuation than applying a flat percentage across all balances.

• Kimzey Medical Supply Aging Schedule Breakdown (December 31, 2028):

  • Not Yet Due: Total balance = $\$16,000,000$; Default rate = $10\%$; Uncollectible estimate = $\$1,600,000$.
  • Individual balances: Shirley Akin ($\$12,000$), Ima Hertz ($\$9,000$), Phil Sikley ($\$6,000$), Others ($\$15,973,000$).
  • 1–60 Days Past Due: Total balance = $\$9,000,000$; Default rate = $30\%$; Uncollectible estimate = $\$2,700,000$.
  • Individual balances: Ben Greene ($\$5,000$), Noah Luck ($\$8,000$), Others ($\$8,987,000$).
  • 61–120 Days Past Due: Total balance = $\$4,000,000$; Default rate = $50\%$; Uncollectible estimate = $\$2,000,000$.
  • Individual balances: Anita Hand ($\$7,000$), Others ($\$3,993,000$).
  • More Than 120 Days Past Due: Total balance = $\$1,000,000$; Default rate = $70\%$; Uncollectible estimate = $\$700,000$.
  • Individual balances: Cara Lott ($\$4,000$), Justin Payne ($\$10,000$), Others ($\$986,000$).
  • Total Portfolio Summary:$\text{Total Accounts Receivable} = \$30,000,000$$\text{Total Required Allowance Ending Balance} = \$1,600,000 + \$2,700,000 + \$2,000,000 + \$700,000 = \$7,000,000$

• Calculating the Year-End Adjusting Entry:

  • The aging schedule establishes the target ending balance of the allowance account.
  • The adjustment is calculated by taking into account the unadjusted balance before adjustment:
  • Beginning balance in 2028: $\$6\text{ million}$ credit
  • Actual write-offs during 2028: $\$4\text{ million}$ debit
  • Unadjusted balance before adjustment: $\$2\text{ million}$ credit
  • Target ending balance: $\$7\text{ million}$ credit
  • Required adjusting credit: \7\text{ million} - \$2\text{ million} = \$5\text{ million}$
  • Adjusting Entry (December 31, 2028):
  • Debit: Bad Debt Expense for $\$5\text{ million}$
  • Credit: Allowance for Uncollectible Accounts for $\$5\text{ million}$

• Interpreting the Pre-Adjustment Allowance Balance:
  • Unadjusted Credit Balance: Occurs when write-offs during the year are less than the beginning allowance (e.g., \6\text{ million} - \$4\text{ million} = \$2\text{ million}$ credit). Indicates the prior year\'s bad debt estimate was higher than actual defaults.
  • Unadjusted Debit Balance: Occurs when write-offs during the year exceed the beginning allowance (e.g., beginning credit of $\$6\text{ million}$ less write-offs of $\$8\text{ million}$ leaves a $\$2\text{ million}$ debit). Indicates the prior year\'s bad debt estimate was lower than actual defaults. The adjustment must cover the debit deficit and establish the required credit balance (\2\text{ million debit} + \$7\text{ million target credit} = \$9\text{ million credit adjustment}$).

• Subsidiary Ledgers:

  • A subsidiary ledger tracks individual debit and credit entries for each individual customer account.
  • The sum of all individual customer balances in the Accounts Receivable subsidiary ledger must equal the balance of the general ledger Accounts Receivable control account reported on the balance sheet.

• Kimzey Medical Supply 2028 Financial Statements:

  • Balance Sheet (December 31, 2028):
  • Current assets: Accounts receivable $\$30\text{ million}$, Less: Allowance for uncollectible accounts $\$(\$7\text{ million})$, Net accounts receivable = $\$23\text{ million}$.
  • Income Statement (Year Ended December 31, 2028):
  • Revenue from credit sales = $\$80\text{ million}$
  • Expenses: Bad debt expense = $\$5\text{ million}$; Other operating expenses = $\$50\text{ million}$; Total operating expenses = $\$55\text{ million}$
  • Net income = \80\text{ million} - \$55\text{ million} = \$25\text{ million}$

The Direct Write-Off Method

• Mechanics and Application:
  • Under the direct write-off method, no allowance is created and bad debt expense is delayed until an account is confirmed uncollectible.
  • Direct Write-Off Entry (September 17, 2028 - write-off of $\$2,000$):
  • Debit: Bad Debt Expense for $\$2,000$
  • Credit: Accounts Receivable for $\$2,000$

• GAAP Compliance and Tax Reporting:

  • Financial Reporting (GAAP): The direct write-off method is generally not permitted under GAAP because it fails to adhere to matching principles and causes receivables to be overstated on the balance sheet during the period of sale. It is only permissible if bad debts are immaterial or practically non-existent.
  • Tax Reporting (IRS): Required for federal income tax calculations, because tax regulations do not allow deductions based on estimates of future bad debts.

• Timing Comparison of Methods:

  • For a $\$100,000$ sale in 2027 with $\$2,000$ defaulting in 2028:
  • Allowance Method: Bad debt expense is recognized in 2027 ($\$2,000$) via year-end adjustment. The 2028 entry debits the Allowance and credits Accounts Receivable, keeping 2028 net income unaffected.
  • Direct Write-Off Method: No entry occurs in 2027 (overstating assets and net income in 2027). Bad Debt Expense is recognized in 2028 ($\$2,000$), reducing 2028 net income.

Notes Receivable and Interest Accounting

• Characteristics and Terminology:
  • Formal, legally enforceable credit contracts supported by a written promissory note.
  • Key Components of a Note:
  • Face Value (Principal): The original cash amount borrowed or extended.
  • Due Date (Maturity Date): The specific date when repayment of principal and final interest is required.
  • Payee: The lender/creditor receiving payment.
  • Maker: The debtor/borrower obligated to pay.
  • Interest Rate: Stated annual percentage rate charged on principal.
  • Balance Sheet Classification: Classified as a current asset if maturity is within one year (or operating cycle); classified as a noncurrent (long-term) asset if maturity exceeds one year.

• Initial Note Recognition:
  • Direct Exchange for Goods/Services (February 1, 2027):
  • Kimzey accepts a six-month, $12\%$ note for $\$10,000$ of services delivered to Justin Payne:
    • Debit: Notes Receivable for $\$10,000$
    • Credit: Service Revenue for $\$10,000$
  • Conversion of Past-Due Accounts Receivable:
  • If customer Justin Payne is unable to settle an existing $\$10,000$ account receivable, Kimzey can reclassify the balance into a formal promissory note:
    • Debit: Notes Receivable for $\$10,000$
    • Credit: Accounts Receivable for $\$10,000$

• Interest Calculation Formula:$\text{Interest} = \text{Face Value} \times \text{Annual Interest Rate} \times \text{Fraction of the Year}$

  • For Kimzey Medical Supply\'s six-month note ($\$10,000$ face value at $12\%$ annual interest):     \text{Interest} = \10,000 \times 12\% \times \frac{6}{12} = \$600$

• Collection at Maturity within Fiscal Period:

  • When Payne satisfies the note on August 1, 2027:
  • Debit: Cash for $\$10,600$
  • Credit: Notes Receivable for $\$10,000$
  • Credit: Interest Revenue for $\$600$

• Multi-Period Notes and Year-End Accruals:
  • Assume the six-month, $12\%$ note for $\$10,000$ is issued on November 1, 2027, maturing May 1, 2028.
  • 2027 Interest Component (2 months: November and December):     \text{Accrued Interest (2027)} = \10,000 \times 12\% \times \frac{2}{12} = \$200$
  • Adjusting Entry (December 31, 2027):
  • Debit: Interest Receivable for $\$200$
  • Credit: Interest Revenue for $\$200$
  • 2028 Interest Component (4 months: January, February, March, April):     \text{Earned Interest (2028)} = \10,000 \times 12\% \times \frac{4}{12} = \$400$
  • Maturity Collection Entry (May 1, 2028):
  • Total cash collected equals principal plus 6 months total interest: $\$10,000 + \$600 = \$10,600$.
  • Debit: Cash for $\$10,600$
  • Credit: Notes Receivable for $\$10,000$
  • Credit: Interest Receivable for $\$200$
  • Credit: Interest Revenue for $\$400$

Financial Ratio Analysis for Receivables

• Receivables Turnover Ratio:

  • Quantifies the efficiency with which a firm collects cash from credit customers, stating the number of times per year the average accounts receivable portfolio is converted into cash:     $\text{Receivables Turnover Ratio} = \frac{\text{Net Credit Sales}}{\text{Average Accounts Receivable}}$
  • Average Accounts Receivable is computed as:     $\text{Average Accounts Receivable} = \frac{\text{Beginning Accounts Receivable} + \text{Ending Accounts Receivable}}{2}$

• Average Collection Period:

  • Expresses the turnover ratio in days, demonstrating how long credit receivables remain unpaid:     $\text{Average Collection Period} = \frac{365\text{ days}}{\text{Receivables Turnover Ratio}}$

• Comparative Corporate Analysis (Oracle Corporation vs. IBM Corporation):

  • Oracle:
  • Net Credit Sales = $\$49,954\text{ million}$
  • Average Accounts Receivable = $\$6,829\text{ million}$
  • Receivables Turnover Ratio: \49,954 \div \$6,829 = 7.3\text{ times}$
  • Average Collection Period: $365 \div 7.3 = 50.0\text{ days}$
  • IBM:
  • Net Credit Sales = $\$59,879\text{ million}$
  • Average Accounts Receivable = $\$6,873\text{ million}$
  • Receivables Turnover Ratio: \59,879 \div \$6,873 = 8.7\text{ times}$
  • Average Collection Period: $365 \div 8.7 = 42.0\text{ days}$
  • Analytical Takeaway: IBM achieves a higher receivables turnover ratio ($8.7$ vs. $7.3$) and shorter collection duration ($42.0$ days vs. $50.0$ days), indicating faster and more efficient conversion of credit sales into liquid cash.

Percentage-of-Credit-Sales Method (Income Statement Approach)

• Core Methodology:

  • An income statement approach that calculates Bad Debt Expense as a direct percentage of current-period credit sales.
  • Key Operational Distinction: The percentage-of-credit-sales method ignores any existing pre-adjustment balance in Allowance for Uncollectible Accounts when determining the adjusting entry amount.

• Comprehensive Comparison of Methods (Kimzey 2028 Data):

  • Base figures: 2028 Credit Sales = $\$80\text{ million}$; Ending Accounts Receivable = $\$30\text{ million}$; Existing Allowance Credit Balance before adjustment = $\$2\text{ million}$.
  • Percentage-of-Receivables Method (Balance Sheet Approach):
  • Assume default rate is $20\%$ of ending receivables.
  • Target allowance ending balance: \30\text{ million} \times 20\% = \$6\text{ million}$.
  • Needed adjustment: Target ($\$6\text{ million}$) less existing balance ($\$2\text{ million}$) = $\$4\text{ million}$.
  • Adjusting entry: Debit Bad Debt Expense $\$4\text{ million}$, Credit Allowance for Uncollectible Accounts $\$4\text{ million}$.
  • Income Statement effect: Bad Debt Expense = $\$4\text{ million}$; Net Income = \80\text{ million} - \$4\text{ million} = \$76\text{ million}$.
  • Balance Sheet effect: Net Receivables = \30\text{ million} - \$6\text{ million} = \$24\text{ million}$.
  • Percentage-of-Credit-Sales Method (Income Statement Approach):
  • Assume default rate is $10\%$ of credit sales.
  • Computed adjustment: \80\text{ million} \times 10\% = \$8\text{ million}$.
  • The existing $\$2\text{ million}$ allowance balance is bypassed during computation.
  • Adjusting entry: Debit Bad Debt Expense $\$8\text{ million}$, Credit Allowance for Uncollectible Accounts $\$8\text{ million}$.
  • Income Statement effect: Bad Debt Expense = $\$8\text{ million}$; Net Income = \80\text{ million} - \$8\text{ million} = \$72\text{ million}$.
  • Balance Sheet effect: Ending Allowance = \2\text{ million} + \$8\text{ million} = \$10\text{ million}$; Net Receivables = \30\text{ million} - \$10\text{ million} = \$20\text{ million}$.

Concept Checks & Discussion

• Concept Check 5–1: Recognition of Credit Receivables

  • Question: Which of the following generally is recorded at the time a company provides services to customers on account?
  • A. Accounts receivable
  • B. Interest receivable
  • C. Notes receivable
  • D. Tax refund claims
  • Correct Answer: A. Accounts receivable.
  • Explanation: Accounts receivable represents cash owed to the enterprise by customers resulting from the sale of goods or delivery of services on credit. In contrast, nontrade receivables consist of tax refund claims, interest receivable, and loans to third parties.

• Concept Check 5–2: Effect of Sales Allowances

  • Question: The effect of a sales allowance will result in which of the following?
  • A. An increase to net income
  • B. A decrease to net income
  • C. An increase to accounts receivable
  • D. An increase to sales revenue
  • Correct Answer: B. A decrease to net income.
  • Explanation: Sales allowances are contra revenues that decrease sales revenue on the income statement, lowering net income. Additionally, the entry reduces assets by crediting the customer\'s accounts receivable balance.

• Concept Check 5–3: Calculation of Net Revenues

  • Question: Which computation determines Net Revenues?
  • A. Total Revenue + Accounts Receivable - Sales Allowances - Sales Discounts
  • B. Total Revenue - Sales Returns - Sales Allowances - Sales Discounts
  • C. Total Revenue - Sales Allowances - Sales Discounts
  • D. Net Income - Change in Accounts Receivable
  • Correct Answer: B. Total Revenue - Sales Returns - Sales Allowances - Sales Discounts.
  • Explanation: Net revenues represents total gross billed revenues minus all contra revenue balances, which include sales returns, allowances, and cash discounts.

• Concept Check 5–4: Nature of Allowance Account

  • Question: Which statement is true regarding Allowance for Uncollectible Accounts?
  • A. It is a liability account.
  • B. It is added to the total of Sales Discounts, Sales Returns, and Sales Allowances.
  • C. It is subtracted from the balance of Accounts Receivable in the balance sheet.
  • D. It appears in the income statement as an expense.
  • Correct Answer: C. It is subtracted from the balance of Accounts Receivable in the balance sheet.
  • Explanation: The allowance is a contra asset account subtracted from gross Accounts Receivable to report receivables at net realizable value on the balance sheet.

• Concept Check 5–6: Financial Statement Effect of Account Write-Offs

  • Question: When writing off an uncollectible account:
  • A. Bad debt expense is debited.
  • B. Net income is decreased.
  • C. Total assets are unchanged.
  • D. The allowance account is credited.
  • Correct Answer: C. Total assets are unchanged.
  • Explanation: The write-off entry debits Allowance for Uncollectible Accounts and credits Accounts Receivable for equal amounts. Both gross receivables and the contra asset fall equally, leaving net accounts receivable, total assets, and net income completely unchanged.

• Concept Check 5–7: Assumptions of the Aging Method

  • Question: Which statement is true regarding the aging method?
  • A. No estimate for uncollectible accounts needs to be made.
  • B. Older accounts are more likely to be collected.
  • C. It is not acceptable for GAAP.
  • D. Older accounts are less likely to be collected.
  • Correct Answer: D. Older accounts are less likely to be collected.
  • Explanation: The aging method is grounded in the observation that older, past-due customer receivables experience higher default rates, producing a more refined estimate than applying a flat percentage.

• Concept Check 5–8: Interpretation of Unadjusted Credit Balance

  • Question: On December 31 before adjusting entries, Allowance for Uncollectible Accounts has a credit balance of $\$2,000$. What does this credit balance indicate?
  • A. The company did not estimate bad debts last year.
  • B. Last year\'s estimate of bad debts was too low.
  • C. The company\'s estimate equals actual bad debts.
  • D. Last year\'s estimate of bad debts was too high.
  • Correct Answer: D. Last year\'s estimate of bad debts was too high.
  • Explanation: The allowance account is credited during year-end adjustments and debited for actual write-offs. A remaining credit balance indicates that write-offs during the period were less than previously estimated.

• Concept Check 5–9: Calculation of Adjustment with Unadjusted Debit Balance

  • Question: On December 31 before adjustments, Accounts Receivable is $\$100,000$ and Allowance for Uncollectible Accounts has a debit balance of $\$2,000$. Bad debts are estimated at $20\%$ of accounts receivable. What is the adjusting entry?
  • A. A debit to Bad Debt Expense for $\$22,000$
  • B. A credit to Allow. for Uncollectible Accts for $\$18,000$
  • C. A credit to Allow. for Uncollectible Accts. for $\$20,000$
  • D. A debit to Bad Debt Expense for $\$20,000$
  • Correct Answer: A. A debit to Bad Debt Expense for $\$22,000$.
  • Explanation: Target allowance ending balance = \100,000 \times 20\% = \$20,000$ credit. To eliminate the existing $\$2,000$ debit balance and establish a $\$20,000$ credit balance, the adjustment must be: $\$2,000 + \$20,000 = \$22,000$. The entry debits Bad Debt Expense for $\$22,000$ and credits Allowance for Uncollectible Accounts for $\$22,000$.

• Concept Check 5–10: Accruing Note Interest Across Fiscal Periods

  • Question: A company accepts a note receivable of $\$5,000$ on September 1, 2027, maturing in 10 months with a stated annual interest rate of $6\%$. What interest revenue is recognized in 2027 and 2028?
  • A. $2027 = \$100$; $2028 = \$150$
  • B. $2027 = \$125$; $2028 = \$125$
  • C. $2027 = \$150$; $2028 = \$100$
  • D. $2027 = \$0$; $2028 = \$250$
  • Correct Answer: A. $2027 = \$100$; $2028 = \$150$.
  • Explanation: For 2027 (September 1 to December 31 = 4 months):     \text{Interest (2027)} = \5,000 \times 6\% \times \frac{4}{12} = \$100$     For 2028 (January 1 to July 1 = 6 months):     \text{Interest (2028)} = \5,000 \times 6\% \times \frac{6}{12} = \$150$

• Concept Check 5–11: Average Collection Period Computation

  • Question: Which of the following is true for a company with an accounts receivable turnover ratio of $10$?
  • A. The company turns over their accounts receivable more than once a month.
  • B. The company would have an average collection period of 36.5 days.
  • C. The company would be considered as doing an efficient job of collecting receivables if the terms were net 30.
  • D. The company would have an average collection period of 20 days.
  • Correct Answer: B. The company would have an average collection period of 36.5 days.
  • Explanation: The average collection period is calculated as:     $\text{Average Collection Period} = \frac{365\text{ days}}{10} = 36.5\text{ days}$

• Concept Check 5–12: Adjustment under Percentage-of-Credit-Sales Method

  • Question: On December 31 before adjustments, Accounts Receivable is $\$100,000$, Allowance for Uncollectible Accounts has a $\$2,000$ credit balance, and Credit Sales are $\$500,000$. Bad debts are estimated at $4\%$ of credit sales. What is the adjusting entry?
  • A. A debit to Bad Debt Expense = $\$18,000$
  • B. A credit to Allowance for Uncoll. Accts. = $\$24,000$
  • C. A credit to Allowance for Uncoll. Accts. = $\$22,000$
  • D. A debit to Bad Debt Expense = $\$20,000$
  • Correct Answer: D. A debit to Bad Debt Expense = $\$20,000$.
  • Explanation: Under the percentage-of-credit-sales method, the adjusting entry ignores the existing allowance balance and calculates bad debt expense directly from sales:     \text{Expense Adjustment} = \500,000 \times 4\% = \$20,000$     The entry debits Bad Debt Expense for $\$20,000$ and credits Allowance for Uncollectible Accounts for $\$20,000$.