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ofPapa
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Business Manila
Administration

CPA REVIEW

THEORY OF ACCOUNTS Gutierrez/Ocampo

HAND OUT NO. 05-36 MAY 2006

ACCOUNTING FOR RECEIVABLES

Receivables: Claims held against customers and others for money, goods, or services.
Classified as either trade or nontrade. Trade receivables (accounts receivable and notes
receivable) are the most significant receivables an enterprise possesses

1. Accounts receivable are oral promises of the purchaser to pay for goods and
services sold.

2. Notes receivable are written promises to pay a certain sum of money on a

specified future date.

Accounts Receivable—Recognition Issues. These involve the concepts of timing and

measurement. Measurement is complicated by:

1. Trade Discounts. These reductions from the list price are not recognized in the
accounting records, customers are billed net of trade discounts.

2. Cash Discounts (Sales Discounts). These are inducements for prompt payment.
a. Gross Method (more practical than the net method). Sales and receivables
are recorded at the gross amount. Sales discounts taken by customers are
debited to the Sales Discounts account which is reported as a reduction of
sales.

b. Net Method. Sales and receivables are recorded at the net amount. Sales
discounts not taken by customers are credited to the Sales Discounts Forfeited
account, which is reported in the other income line item of the profit or loss
statement.

3. Interest Element. Theoretically, receivables should be measured at their present

value but accountants have chosen to ignore the implicit interest element in
receivables which are due within one year.

Accounts Receivable—Valuation Issues. Receivables are valued at net realizable

value (the net amount expected to be received in cash).

Methods of accounting for uncollectible accounts:

a. Direct write-off method—When a specific account is determined to be

uncollectible (which may not occur in the period of sale), Bad Debt Expense is
debited and Accounts Receivable is credited. This method is theoretically
undesirable because it:

(1) makes no attempt to match revenues and expenses.

(2) does not result in receivables being stated at net realizable value in the
balance sheet.

b. Allowance method—At the end of each accounting period an estimate is

made of expected losses from uncollectible accounts. This estimate is debited
to Bad Debt Expense and credited to the Allowance for Doubtful Accounts.
This method is justified because a company has experienced a loss the
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moment customers receive goods or services that they will never pay for. This
is true even if the specific identity of such customers will not be known for
some time.

Methods of estimating bad debt expense under the allowance method.

(a) Percentage-of-Sales (Income Statement Approach). Bad debt

expense is estimated directly by multiplying a percentage times credit
sales.

(b) Percentage-of-Receivables (Balance Sheet Approach):

1) First the required ending balance in the Allowance for Doubtful

Accounts is estimated by multiplying a percentage (a single
composite rate) times the ending outstanding receivables.

2) Then bad debt expense is equal to the difference between the

required ending balance and the existing balance in the
Allowance account.

(c ) Percentage of Aging of Receivables - same procedure in

percentage of receivables, the only difference is the percentage
use for each term in the aging schedule.

NOTE
Net accounts receivable is the balance in accounts receivable less the allowance
for bad debts. Also remember that net receivables do not change when a specific
account is written off since both accounts receivable and the allowance account are
reduced by the same amount.
 
MULTIPLE CHOICE:

1. A discount given to a customer for purchasing a large volume of merchandise is typically

referred to as a
a. quantity discount.
b. cash discount.
c. trade discount.
d. Size discount.
c
2. When the direct write-off method of recognizing bad debt expense is used, the entry to
write off a specific customer account would
a. increase net income.
b. have no effect on net income.
c. increase the accounts receivable balance and increase net income.
d. decrease the accounts receivable balance and decrease net income.
d
3. When comparing the allowance method of accounting for bad debts with the direct write-
off method, which of the following is true?
a. The direct write-off method is exact and also better illustrates the matching principle.
b. The allowance method is less exact but it better illustrates the matching principle.
c. The direct write-off method is theoretically superior.
d. The direct write-off method requires two separate entries to write off an uncollectible
account.
b
4. When the allowance method of recognizing bad debt expense is used, the entries at the
time of collection of an account previously written off would
a. Decrease the allowance for doubtful accounts
b. Increase net income
c. Have no effect on the allowance for doubtful accounts
d. Have no effect on net income
d

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5. When the allowance method of recognizing bad debt expense is used, the entry to
record the write-off of a specific uncollectible account would decrease
a. allowance for doubtful accounts.
b. net income.
c. net realizable value of accounts receivable.
d. working capital.
a
6. When the allowance method of recognizing bad debt expense is used, the entries at the
time of collection of a small account previously written off would
a. increase net income.
b. increase the allowance for doubtful accounts.
c. decrease net income.
d. decrease the allowance for doubtful accounts.
b
9. A method of estimating bad debts that focuses on the balance sheet rather than the
income statement is the allowance method based on
a. direct write-off.
b. aging the trade receivable accounts.
c. credit sales.
d. specific accounts determined to be uncollectible.
b
10. The entry

Accounts Receivable xxx

Allowance for Uncollectible Accounts xxx

would be made when

a. a customer pays its account balance.
b. a customer defaults on its account.
c. a previously defaulted customer pays its outstanding balance.
d. estimated uncollectible receivables are too low.
c
12. A company uses the allowance method for recognizing doubtful accounts. The entry to
record the writeoff of a specific uncollectible account
a. Affects neither net income nor working capital
b. Affects neither net income nor accounts receivable
c. Decreases both net income and working capital
d. Decreases both net income and accounts receivable
a
15. The accounts receivable turnover ratio is computed by dividing
a. gross sales by ending net receivables.
b. gross sales by average net receivables.
c. net sales by ending net receivables.
d. net sales by average net receivables.
d
16. Which of the following methods of determining bad debt expense does not properly
match expense and revenue?
a. Charging bad debts with a percentage of sales under the allowance method.
b. Charging bad debts with an amount derived from a percentage of accounts
receivable under the allowance method.
c. Charging bad debts with an amount derived from aging accounts receivable
under the allowance method.
d. Charging bad debts as accounts are written off as uncollectible.
d
17. Which of the following methods of determining annual bad debt expense best
achieves the matching concept?
a. Percentage of sales
b. Percentage of ending accounts receivable
c. Percentage of average accounts receivable
d. Direct write-off
a

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18. Which of the following is a generally accepted method of determining the amount of
the adjustment to bad debt expense?
a. A percentage of sales adjusted for the balance in the allowance
b. A percentage of sales not adjusted for the balance in the allowance
c. A percentage of accounts receivable not adjusted for the balance in the
allowance
d. An amount derived from aging accounts receivable and not adjusted for the
balance in the allowance
b
19. The advantage of relating a company's bad debt expense to its outstanding accounts
receivable is that this approach
a. gives a reasonably correct statement of receivables in the balance sheet.
b. best relates bad debt expense to the period of sale.
c. is the only generally accepted method for valuing accounts receivable.
d. makes estimates of uncollectible accounts unnecessary.
a
20. In the case of long-term installments receivable (real estate installment sales) where a
major portion of the receivables will be collected beyond the normal operating cycle
a. The entire receivables are classified as current without disclosure of the amount not
currently due
b. The entire receivables are classified as noncurrent
c. Only the portion currently due is classified as current and the balance as noncurrent
d. The entire receivables are classified as current with disclosure of the amount not
currently due
c
21. Receivables from subsidiaries and affiliates, if significant should be classified as
a. Current assets
b. Noncurrent assets
c. Either as noncurrent or current depending on the expectation of realizing them within
one year or over one year
d. Intangible assets
c
22. Receivables from officers, directors and employees for goods sold or services rendered
in the ordinary course of business
a. Are considered current if proper control is exercised in granting credit and the
accounts are currently collectible
b. Are not included in trade accounts receivable
c. Are included in current assets even if the receivables are actually loans and
advances and the collection is unlikely within a year
d. Are always classified as noncurrent
a
23. If a company employs the gross method of recording accounts receivable from
customers, then sales discounts taken should be
a. reported as a deduction from sales in the income statement.
b. reported as an item of "other expense" in the income statement.
c. reported as a deduction from accounts receivable in determining the net
realizable value of accounts receivable.
d. reported as sales discounts forfeited in the cost of goods sold section of the
income statement.
a
24. Assuming that the ideal measure of short-term receivables in the balance sheet is
the discounted value of the cash to be received in the future, failure to follow this
practice usually does not make the balance sheet misleading because
a. most short-term receivables are not interest-bearing.
b. the allowance for uncollectible accounts includes a discount element.
c. the amount of the discount is not material.
d. most receivables can be sold to a bank or factor.
c
25. Installments receivable arising from sales of household appliances should be
classified as
a. Current assets
b. Noncurrent assets

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c. Current assets; however, the amount not realizable within one year should be
disclosed, if material
d. None of these
c

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