Philippine School of Business Administration

826 R. Papa St. Sampaloc, Manila

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
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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 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.

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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
5. When a specific customer’s account receivable is written off as uncollectible,
what will be the effect on net income under each of the following methods of
recognizing bad debt expense?
Allowance Direct writeoff
a. None Decrease
b. Decrease None
c. Decrease Decrease
d. None None
A
6. 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.

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7. When a specific customer's account is written off by a company using the

allowance method, the effect on net income and the net realizable value of the
accounts receivable is

Net Realizable Value

Net Income of Accounts Receivable

a. None None
b. Decrease Decrease
c. Increase Increase
d. Decrease None
A

8. 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
11. Credit balances in accounts receivable should be classified as
a. Current liability
b. Part of accounts payable
c. Noncurrent liability
d. Deduction from accounts receivable
A
12. A method of estimating doubtful accounts that focuses on the income
statement rather the balance sheet is the allowance method based on
a. Direct writeoff c. Credit sales
b. Aging of trade accounts receivable d. Balance of accounts
receivable

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13. A method of estimating doubtful accounts that emphasizes asset valuation

rather than income measurement is the allowance method based on
a. Aging of receivables
b. Direct writeoff
c. Gross sales
d. Credit sales less sales returns and allowances
A
14. 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
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.

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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
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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