Lecture10 - Lecture 10 Accounts Receivable 1 So far when we...

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1 Lecture 10 Accounts Receivable
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2 So far, when we discussed the accounting for credit sales and accounts receivable, we assumed that the firm would always collect the full amount due. This is not necessarily realistic. Let’s examine the accounting in the more realistic situation where some of the receivables are not collected.
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3 Case 1 The firm sells an item having a normal selling price of $100 to a customer who, it knows, for certain, will pay the full amount. The entry that would be made at the time of the sale is Accounts Receivable 100 Sales Revenue 100 What is the rationale for the journal entry? The firm has acquired a legal right to receive cash which, it knows for certain, will be converted into cash in due course. The legal right has an economic value and, for that reason, it represents an asset (i.e. an inflow of cash at some future date) -- hence the debit to accounts receivable to record the increase. Since the additional asset was obtained as a result of the income generating activities of the business, this increase (in the assets) represents revenue (an increase in shareholders’ equity).
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4 Case 2 The firm “sells” an item with a normal selling price of $100, on credit, to a customer who, it knows, for certain, will not pay the amount due. Even though the firm may have a legal right to receive the cash, that right has no economic value because that right cannot be converted to cash. Thus, the right does not represent an asset. And we would not be justified recording any increase to the firm’s asset. Indeed, we might be inclined to call this “sale” a charitable contribution rather than a sale in spite of the fact that it has the (legal) form of a credit sale.
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5 The reality is somewhere between Case 1 and Case 2 It is likely that the total amount actually collected for all credit sales will be less than the total of the amounts expected when the sale was made. Uncollectible accounts Sales discounts Sales returns When and how should the financial statements reflect the fact that the net cash inflow from credit sales may be less than the amount originally expected at the time of the originating transaction?
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6 Two alternatives
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This note was uploaded on 05/20/2010 for the course ACCT 101 taught by Professor Briancadman during the Spring '10 term at Penn College.

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Lecture10 - Lecture 10 Accounts Receivable 1 So far when we...

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