Financial accounting 2.0 chapter 7 solutions.doc

Financial accounting 2.0 chapter 7 solutions.doc - Chapter...

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Chapter 7 Solutions Answers to Questions 1) Accounts receivable are amounts owed to a company by its customers usually resulting from the sale of inventory or services on credit. They are assets of the company because they have probable future economic benefit. The receivable balance is reported on the balance sheet at its estimated net realizable value, the amount of cash that is expected to be collected. 2) The net realizable value of accounts receivable is determined by subtracting the amount of accounts receivable the company believes it will not collect from the total of all accounts receivable. This estimation is derived by studying numerous factors such as the past history of collections and current economic conditions. 3) To estimate the amount of uncollectible accounts, a company might consider its history of collections, the effectiveness of its credit policy, current economic conditions, trends in its industry, amounts reported by similar companies, the current percentage of its accounts that are overdue, and the efficiency of its collection policies. 4) The Allowance for Doubtful Accounts represents the amount of accounts receivable held at the present moment that a reporting company believes will not be collected. It is a contra asset account used to reduce reported receivables from the current total to an expected net realizable value. 5) A contra account is one that always appears with another account to lower the value reported for that account. In Chapter 7, the allowance for doubtful accounts reduces the amount reported for accounts receivable to net realizable value. 6) Bad debt expense should be recorded in the period that allows it to be matched with the revenue generated from these sales. Because the exact amount will not be known at that time, bad debts are initially reported based on an estimate. 7) Companies do not know which of their receivables will prove to be uncollectible when preparing information for reporting purposes. Plus, the allowance amount is no more than an estimate. There is simply too much uncertainty to reduce the accounts receivable T-account balance directly. By setting up a separate contra account, the actual receivables can be kept separate from the estimation of the uncollectible amounts but the net realizable value can still be reported by netting the two. 8) To write off an account, a company debits the Allowance for Doubtful Accounts and credits Accounts Receivable. In both cases, the balance is being reduced. The company has less receivables and the amount estimated as uncollectible has also been decreased. 9) The write off of an account receivable does not change the amount shown as the net realizable value. Removing an account does not alter the estimation of the amount of
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cash that will be collected. The receivable balance is reduced by $12,000 as is the allowance account. The net of the two remaining figures has not changed.
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