Acc Chapter 8 notes.docx - Obj 1-4 Pages 351-367 Pros and Cons of Extending Credit The advantage of extending credit is that it helps business customers

Acc Chapter 8 notes.docx - Obj 1-4 Pages 351-367 Pros and...

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Obj 1-4, Pages 351-367 Pros and Cons of Extending Credit The advantage of extending credit is that it helps business customers buy products and services, thereby increasing the seller’s revenues. The disadvantage of extending credit are the following additional costs introduced: 1. Increased wage costs. If credit is extended, seller will have to hire people to ( a ) evaluate whether each customer is creditworthy, ( b ) track how much each customer owes, and ( c ) follow up to collect the receivable from each customer 2. Bad debt costs . Some customers dispute what they owe, or they run into financial difficulties and pay only a fraction of their account balances. These “bad debts,” as they are called, can be a significant additional cost of extending credit. 3. Delayed receipt of cash . Can take 30-60 days before receiving the cash. During this period, seller may have to take out a short-term bank loan to pay for other business activities. The interest on such a loan would be another cost of extending credit to customers. Most managers find the additional revenue (or the gross profit) from selling on account to business customers is greater than the additional costs mentioned Similar pros and cons for deciding whether to create notes receivable (Note Receivable a promise that requires another party to pay the business according to a written agreement; generally charge interest from the day they are signed to the day they are collected) Notes receivable are viewed as a stronger legal claim than accounts receivable Typically used when a company sells large dollar value items (like cars), offers extended pay periods, or lends money to individuals or businesses Need a new note to be created for every transaction Accounts Receivable and Bad Debts Objectives when accounting for accounts receivable and bad debts: 1. Report accounts receivable at the amount the company expects to collect (“net realizable value”) 2. Match the cost of bad debts to the accounting period in which the related credit sales are made *Aim is to reduce both Accounts Receivable and Net Income by the amount of credit sales that are unlikely to be collected If you record sales in one period when they occur and bad debts in a different period when they are discovered, you will violate the expense recognition principle This failure to match bad debt expense with sales revenue in the same period will lead
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