Week 9-ACCT1101

• Types of Receivables:

  • Accounts Receivable: Amounts owed by customers for goods or services sold on credit.
  • Notes Receivable: Written promises to pay a certain sum of money on a specified future date.
  • Interest Receivable: Accrued interest on outstanding loans or investments.
  • Other Receivables: Any other amounts owed to the company that are not categorized as accounts or notes receivable, such as advances to employees or suppliers.
• Accounts Receivable:Accounts receivable represent the amount owed by customers for goods or services sold on credit. Accounting recognizes and values them through the accrual basis. This means that revenue is recognized when earned (when goods are delivered or services are provided), regardless of when the cash is received. Accounts receivable are initially recorded at the invoiced amount and are then adjusted for any allowances for doubtful accounts.
• Bad and Doubtful Debts:Bad debts refer to amounts that are unlikely to be collected from customers, while doubtful debts are amounts that may not be fully collectible. These are accounted for by creating an allowance for doubtful accounts, which is a contra-asset account that reduces the carrying amount of accounts receivable. When a debt is deemed uncollectible, it is written off against the allowance account.
• Management and Control of Accounts Receivable:The principles involved in managing and controlling accounts receivable include:

  • Establishing credit policies to evaluate customers' creditworthiness.
  • Monitoring accounts receivable aging to identify overdue accounts.
  • Implementing collection procedures to follow up on overdue payments.
  • Regularly reviewing and adjusting the allowance for doubtful accounts based on credit risk assessments.
• Inventory Management:Inventory on hand is determined through physical stocktakes, where the actual quantities of inventory items are counted and compared to the recorded quantities. The cost of inventory is determined using various methods such as FIFO (First-In, First-Out), LIFO (Last-In, First-Out), or weighted average cost.
• Cost of Sales:Under the periodic inventory system, cost of sales is determined by adding the beginning inventory to purchases and subtracting the ending inventory. Different cost flow assumptions (FIFO, LIFO, weighted average) result in different cost of sales figures.
• Valuation of Ending Inventory:Under the perpetual inventory system, the valuation of ending inventory is based on the actual cost of each item sold, determined using the chosen cost flow assumption (FIFO, LIFO, weighted average).
• Comparison of Cost Flow Assumptions:Cost flow assumptions affect both the cost of sales and the valuation of ending inventory. FIFO typically results in higher ending inventory and lower cost of sales compared to LIFO, while the weighted average method falls in between.
• Lower of Cost and Net Realizable Value (LCNRV) Rule:Inventory is valued at the lower of cost and net realizable value, ensuring conservatism in financial reporting. If the net realizable value (estimated selling price less any selling costs) of inventory falls below its cost, inventory is written down to its net realizable value.
• Recording Sales and Purchases Returns:Sales returns are recorded as a decrease in accounts receivable (or cash) and a decrease in sales revenue, while purchases returns are recorded as a decrease in inventory and an increase in accounts payable (or cash).
• Effects of Inventory Errors on Financial Statements:Errors in determining inventory can affect the balance sheet (by misstating assets) and the income statement (by misstating cost of goods sold and net income). Overstating inventory may inflate assets and net income, while understating inventory may have the opposite effect.
• Inventory Valuation Methods:The retail inventory method estimates the value of inventory based on the ratio of cost to retail price. The gross profit method estimates the value of ending inventory by applying the gross profit percentage to sales.
• Presentation of Inventory in Financial Statements:Inventory is typically presented on the balance sheet as a current asset, either as "Inventory" or broken down into categories such as "Raw Materials," "Work in Progress," and "Finished Goods."
• Effects of Cost Flow Assumptions on Ratios:Different cost flow assumptions can affect financial ratios such as gross profit margin, inventory turnover, and return on assets. For example, FIFO may result in a higher gross profit margin compared to LIFO in inflationary environments.