Accounts Receivables Paper 2

Answer (C) is correct. The entry to record bad debt expense under the allowance method is to debit bad debt expense and credit the allowance account. When a specific account is then written off, the allowance is debited and accounts receivable credited. Net income is affected when bad debt expense is recognized, not at the time of the write-off. Because accounts receivable and the allowance account are decreased by the same amount, a write-off of an account also has no effect on the net amount of accounts receivable.

Answer (D) is correct. The allowance for uncollectible accounts at year end should have a credit balance of $30,000. This amount is equal to the $1 million of accounts receivable multiplied by the 3% that are estimated to become uncollectible

Answer (B) is correct. An increase in discounts taken accompanied by declines in receivables balances and doubtful accounts all indicate that collections on the increased sales have been accelerated. Accordingly, the average collection period must have declined. The average collection period is a ratio calculated by dividing the number of days in a year (365) by the receivable turnover. Thus, the higher the turnover, the shorter the average collection period. The turnover increases when either sales (the numerator) increase, or receivables (the denominator) decrease. Accomplishing both higher sales and a lower receivables increases the turnover and results in a shorter collection period.

Answer (A) is correct. An increase in discounts taken accompanied by declines in receivables balances and doubtful accounts all indicate that collections on the increased sales have been accelerated. Accordingly, the average collection period must have declined. The average collection period is a ratio calculated by dividing the number of days in a year (365) by the receivable turnover. Thus, the higher the turnover, the shorter the average collection period. The turnover increases when either sales (the numerator) increase, or receivables (the denominator) decrease. Accomplishing both higher sales and a lower receivables increases the turnover and results in a shorter collection period.

Answer (A) is correct. The average collection period measures the number of days between the date of sale and the date of collection. It should be related to a firm’s credit terms. For example, a firm that allows terms of 2/15, net 30, should have an average collection period of somewhere between 15 and 30 days.

Answer (C) is correct. A firm’s average gross receivables balance can be calculated by multiplying average daily sales by the average collection period (days’ sales outstanding . Alternatively, annual credit sales can be divided by the accounts-receivable turnover (net credit sales + average accounts receivable) to obtain the average balance in receivables.

Answer (D) is correct. The purpose of an aging of receivables is to classify receivables by due date. Those that are current (not past due) are listed in one column, those less than 30 days past due in another column, etc. The amount in each category can then be multiplied by an estimated bad debt percentage that is based on a company’s credit experience and other factors. The theory is that the oldest receivables are the least likely to be collectible. Aging the receivables and estimating the uncollectible amounts is one method of arriving at the appropriate balance sheet valuation of the accounts receivable account.

Answer (D) is correct. Increasing the quality of the accounts rejected means that fewer sales will be made. The company is therefore not trying to maximize its sales or increase its bad debt losses. The objective is to reduce bad debt losses and thereby maximize profits.

Answer (C) is correct. If the cause of increased sales is an increase in the cash discount, it can be inferred that the additional customers would pay during the discount period. Thus, cash would be collected more quickly than previously and the cash conversion cycle would be shortened.

Answer (D) is correct. Because these terms involve an annual interest cost of over 36%, a company would not offer them unless it desperately needed cash. Also, credit terms are typically somewhat standardized within an industry. Thus, if most companies in the industry offer similar terms, a firm will likely be forced to match the competition or lose market share.