SM_Chap008

Fundamentals of Financial Accounting with Annual Report

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Unformatted text preview: Chapter 08 - Reporting and Interpreting Receivables, Bad Debt Expense, and Interest Revenue Chapter 8 Reporting and Interpreting Receivables, Bad Debt Expense, and Interest Revenue ANSWERS TO QUESTIONS 1. The advantages of extending credit are that it allows a company to compete effectively with competitors who extend credit. The additional gross profit earned from selling on account is greater than the additional costs incurred. The disadvantages of selling on credit include increased wage costs incurred in hiring personnel to monitor and track credit customers, bad debt costs from accounts that are collected late or not at all, and delayed receipt of cash. 2. Before discontinuing its credit card program, Kohls Corporation would have compared the gross profit given up as a result of lost credit card sales to the expenses given up (e.g., bad debts, wages and administration, interest). Presumably, Kohls cancelled its private credit card program because the extra expenses to run the credit card program exceeded the gross profit earned from it. In making this decision, Kohls would note that consumers could use national credit cards (such as Visa and Mastercard) rather than the Kohls credit card. 3. In conformity with the matching principle, the allowance method records Bad Debt Expense in the same period in which the credit was granted and the sale was made. Following the conservatism concept, accounting rules require accounts receivable be reported at the amount which the company actually expects to collect rather than the total that it would collect if everyone paid. 4. Using the allowance method, Bad Debt Expense is recognized in the period in which (a) sales related to the uncollectible account were made. 5. The write-off of uncollectible accounts using the allowance method decreases the asset Accounts Receivable and decreases the contra-asset Allowance for Doubtful Accounts by the same amount. As a consequence, (a) net income is unaffected and (b) net accounts receivable is unaffected. 8-1 Chapter 08 - Reporting and Interpreting Receivables, Bad Debt Expense, and Interest Revenue 6. With the aging of accounts receivables method, the calculated amount is the desired balance to which the Allowance for Doubtful Accounts is to be adjusted. That is, the difference between this calculated amount and the existing balance in the Allowance for Doubtful Accounts is the amount recorded as an adjustment to Bad Debt Expense and the Allowance for Doubtful Accounts. In contrast, with the percentage of credit sales method, the calculated amount is the amount recorded as an adjustment to Bad Debt Expense and the Allowance for Doubtful Accounts. 7. Using the allowance method, the company would report $300 of revenue and $15 of Bad Debt Expense in 2009. In 2010, the write off would reduce Accounts Receivable and the Allowance for Doubtful Accounts, but it would not directly affect Net Income. (The write-off could indirectly affect Net Income in 2010 if the affect Net Income....
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SM_Chap008 - Chapter 08 - Reporting and Interpreting...

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