1.

What are two methods of recording accounts receivable transactions when a cash
discount situation is involved? Which is more theoretically correct? Which is used in
practice more of the time? Why?
Two methods for recording accounts receivable transactions with cash discounts are the
gross method and the net method. Theoretically, the net method is considered more
accurate as it records the expected cash inflow. However, the gross method is more
commonly used in practice as it is simpler and aligns with historical practices. It avoids
frequent adjustments and is easier to apply, making it a practical choice for many
businesses.
2. What are the basic problems that occur in the valuation of accounts receivable?
Basic problems in the valuation of accounts receivable include uncertainties about
collectability, changes in customer creditworthiness, and the need for estimating allowances
for doubtful accounts. Additionally, fluctuations in market interest rates can impact present
value calculations, while changes in economic conditions may affect the overall credit risk
associated with receivables. Regular assessments and adjustments are necessary to
address these challenges accurately.
3. What is the theoretical justification of the allowance method as contrasted with the
direct write-off method of accounting for bad debts?
The theoretical justification for the allowance method over the direct write-off method lies in
matching principles and conservatism. The allowance method anticipates and matches
estimated bad debts with the period of sale, adhering to the matching principle. It provides a
more accurate representation of the accounts receivable's realizable value. In contrast, the
direct write-off method delays recognition until specific accounts are deemed uncollectible,
potentially distorting financial statements and violating the principle of conservatism. The
allowance method aligns with a more accurate portrayal of a company's financial position
and performance.
4. Indicate how the percentage-of-receivables method, based on an aging schedule,
accomplishes the objectives of the allowance method of accounting for bad debts.
What other methods, besides an aging analysis, can be used for estimating
uncollectible accounts?
The percentage-of-receivables method, utilizing an aging schedule, aligns with the
allowance method by estimating bad debts based on the age of receivables. Other methods,
such as percentage-of-sales and specific identification, as well as judgment-based
approaches like industry averages, historical data, and economic factors, can also be used
to estimate uncollectible accounts in the allowance method.
5. Of what merit is the contention that the allowance method lacks the objectivity of the
direct write-off method? Dis- cuss in terms of accounting’s measurement function.
The contention that the allowance method lacks the objectivity of the direct write-off method
is rooted in the subjective nature of estimating potential bad debts. The allowance method
requires judgment and historical data for creating a reserve, introducing an element of
uncertainty. Despite this, the allowance method is preferred for its alignment with the
matching principle, providing a more accurate representation of a company's financial
position over time. The trade-off between objectivity and the accuracy of financial reporting is
a key consideration in choosing between these two methods.
6. What is the normal procedure for handling the collec- tion of accounts receivable
previously written off using the direct write-off method? The allowance method?
For the direct write-off method, collecting a previously written-off account involves reinstating
the receivable and recognizing the cash collection. In the allowance method, it requires two
entries: reducing the allowance for doubtful accounts to reflect the recovery of the estimated
bad debt and recording the actual cash collection.
7. What is “imputed interest”? In what situations is it nec- essary to impute an interest
rate for notes receivable? What are the considerations in imputing an appropriate
interest rate?
"Imputed interest" is a hypothetical interest rate assigned to financial transactions when the
stated rate differs significantly from market rates. It is necessary for notes receivable when
stated rates are absent or substantially differ. Considerations include market rates, borrower
creditworthiness, and regulatory factors to ensure fair representation in financial reporting.
8. What is the fair value option? Where do companies that elect the fair value option
report unrealized holding gains and losses?
The fair value option enables companies to value specific financial instruments at their fair
value rather than historical cost. When companies elect this option, unrealized holding gains
and losses related to these instruments are reported in the income statement. This choice
offers more timely recognition of changes in the instruments' values.
9. Indicate three reasons why a company might sell its receivables to another company.
1. **Liquidity Improvement:**
- Selling receivables provides immediate cash inflow, enhancing liquidity for operational
needs or strategic investments.
2. **Risk Mitigation:**
- Transferring receivables can help mitigate credit and collection risks, as the purchasing
company assumes responsibility for collecting on the accounts.
3. **Focus on Core Activities:**
- Companies may sell receivables to specialized entities, allowing them to concentrate on
core business functions while offloading the administrative burden of managing and
collecting receivables.
10. When is the financial components approach to recording the transfers of receivables
used? When should a trans- fer of receivables be recorded as a sale?
The financial components approach is used when a company transfers part of its financial
assets, retaining ongoing involvement. A transfer of receivables should be recorded as a
sale when there is a substantive transfer of control, no effective control is maintained, and
risks and rewards are significantly transferred to the transferee.
11. Moon Hardware is planning to factor some of its receiv- ables. The cash received will
be used to pay for inven- tory purchases. The factor has indicated that it will require
“recourse” on the sold receivables. Explain to the controller of Moon Hardware what
“recourse” is and how the recourse will be reflected in Moon’s finan- cial statements
after the sale of the receivables.
"Recourse" in factoring indicates that Moon Hardware retains responsibility for the collection
of the receivables in case the factor is unable to collect. In Moon's financial statements after
the sale, the factored receivables will still be reported, but a contingent liability for the
potential recourse obligation will also be disclosed. This reflects the continuing risk
associated with the collectability of the receivables sold.
12. What is the accounts receivable turnover, and what type of information does it
provide?
The accounts receivable turnover is a ratio that gauges how efficiently a company collects its
receivables. Calculated by dividing net credit sales by the average accounts receivable, it
indicates how many times, on average, a company collects its receivables in a specific
period. A higher turnover suggests effective receivables management, while a lower turnover
may signal collection challenges or credit policy inefficiencies.
13. What are the general rules for measuring and recogniz- ing gain or loss by both the
debtor and the creditor in an impairment?
In an impairment:
**Debtor:**
- Recognizes a loss equal to the difference between the carrying amount of the impaired
receivable and the present value of expected future cash flows.
**Creditor:**
- Recognizes a gain equal to the difference between the carrying amount of the impaired
receivable and the consideration paid for the impaired debt.
These general rules apply to measuring and recognizing gain or loss for both the debtor and
the creditor in an impairment scenario.
14. Describe the estimation of the allowance, based on expected cash flows.
The estimation of the allowance based on expected cash flows involves assessing the
present value of future cash flows associated with receivables. This calculation considers
factors like historical collection patterns, economic conditions, and any identifiable risks. The
resulting estimate helps determine the appropriate allowance for doubtful accounts, aligning
with the goal of accurately reflecting the potential losses in a company's financial statements.