Page 394 - Accounting Principles (A Business Perspective)

This book is licensed under a Creative Commons Attribution 3.0 License

Based on 365 days, we calculated the number of days' sales for each of these hypothetical companies:
Accounts Receivable
Company Turnover Number of
Day's Sales in
Abercrombie & Fitch 88.43 4.1
The Limited, Inc. 10.00 36.5
These companies have collection periods ranging from 4.1 to 36.5 days. Assuming credit terms of 2/10, n/30,
one would expect the average collection period to be under 30 days. If customers do not pay within 10 days and take
the discount offered, they incur an annual interest rate of 36.5 per cent on these funds. (They lose a 2 per cent

discount and get to use the funds another 20 days, which is equivalent to an annual rate of 36.5 per cent.)
Having studied receivables and payables in this chapter, you will study plant assets in the next chapter. These
long-term assets include land and depreciable assets such as buildings, machinery, and equipment.
Understanding the learning objectives
• Companies use two methods to account for uncollectible accounts receivable: the allowance method, which
provides in advance for uncollectible accounts; and the direct write-off method, which recognizes uncollectible

accounts as an expense when judged uncollectible. The allowance method is the preferred method and is the
only method discussed and illustrated in this text.
• The two basic methods for estimating uncollectible accounts under the allowance method are the
percentage-of-sales method and the percentage-of-receivables method.
• The percentage-of-sales method focuses attention on the income statement and the relationship of
uncollectible accounts to sales. The debit to Uncollectible Accounts Expense is a certain per cent of credit sales
or total net sales.

• The percentage-of-receivables method focuses attention on the balance sheet and the relationship of the
allowance for uncollectible accounts to accounts receivable. The credit to the Allowance for Uncollectible
Accounts is the amount necessary to bring that account up to a certain percentage of the Accounts Receivable
balance. Either one overall percentage or an aging schedule may be used.
• Credit cards are charge cards used by customers to charge purchases of goods and services. These cards are
of two types—nonbank credit cards (such as American Express) and bank credit cards (such as VISA).
• The sale is recorded at the gross amount of the sale, and the cash or receivable is recorded at the net
amount the company will receive.

• Liabilities result from some past transaction and are obligations to pay cash, provide services, or deliver
goods at some time in the future.
• Current liabilities are obligations that (1) are payable within one year or one operating cycle, whichever is
longer, or (2) will be paid out of current assets or create other current liabilities.
• Long-term liabilities are obligations that do not qualify as current liabilities.
• Clearly determinable liabilities are those for which the existence of the liability and its amount are certain.
An example is accounts payable.

• Estimated liabilities are those for which the existence of the liability is certain, but its amount can only be
estimated. An example is estimated product warranty payable.

Accounting Principles: A Business Perspective 395 A Global Text