Lecture 8 0220 - ORIE 350 Lecture Eight Accounts Receivable...

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    ORIE 350 Lecture Eight February 20, 2007
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    Accounts Receivable Accounts receivable account is treated as a current asset. We want to be sure to record this asset at its correct value. The value we show on the balance sheet should be the same as the amount of cash we expect to convert it into. It is important to have an accurate figure, as accounts receivable can be quite large for some firms. For example, General Motors has over $20 billion in receivables.
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    Accounts Receivable Using accrual accounting, we recognize sales on account as revenue. Some of these customers will fail to pay. Thus, we have to record some amount each period to recognize this. This amount will be recorded as an expense, a “bad debt expense” This is typically small (like 2% of total sales).
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    Direct Write Off Method This method is common sense. Using this method, when I learn about an existing Accounts Receivable that I cannot collect upon, I will charge it off as an expense.
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    Direct Writeoff Your company sold an item on account to another company for $20,000 in 2003. You recorded this revenue in 2003. In 2004, you find that this company has gone bankrupt and you reverse this revenue. The Matching Principle has been violated! The revenue is recorded in 2003, the expense in 2004.
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    Direct Charge-Off Disadvantages: 1. The expense occurs in a different period than does the initial revenue, which violates the matching principle. 2. The direct charge-off method allows firms to manipulate earnings by deciding which customer’s accounts have become uncollectible.
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