Understanding Trade Receivables

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Questions and Answers

What inventory cost flow method assumes that the oldest inventory items are sold first?

Last in, First out (LIFO)

Weighted Average

Specific Identification

First in, First out (FIFO) (correct)

Which method of inventory measurement is prohibited by the current standards?

Weighted Average

Moving Average

First in, First out (FIFO)

Last in, First out (LIFO) (correct)

In a period of inflation, what is the likely outcome of using the FIFO method on net income?

Reduced sales revenue

No effect on net income

Understated net income

Higher net income (correct)

What is a significant drawback of using the FIFO method for inventory in financial reporting?

Improper matching of cost against revenue Signup and view all the answers

What does the weighted average method primarily focus on when calculating inventory costs?

Calculating an average cost for all units Signup and view all the answers

What is the primary distinction of the net method for recording accounts receivable?

Accounts are recorded at net amount of the invoice, including discounts. Signup and view all the answers

Which accounting method requires recognizing a bad debt loss only when accounts are deemed worthless?

Direct writeoff method Signup and view all the answers

What must occur when a collection is made on an account previously written off as uncollectible?

Recharge the customer's account and record the collection as usual. Signup and view all the answers

Why might small businesses prefer the direct writeoff method?

It is simple to apply and straightforward. Signup and view all the answers

Which of the following statements is true regarding the allowance method?

It requires the estimation of cash discounts based on past experience. Signup and view all the answers

What is the common treatment for accounts that are only doubtful of collection?

No adjustment is necessary until they are proven uncollectible. Signup and view all the answers

At what point does ownership transfer under the 'FOB shipping point' term?

Upon shipment of the goods Signup and view all the answers

What is a significant drawback of the direct writeoff method?

It violates the matching principle of accounting. Signup and view all the answers

Who is responsible for freight charges when goods are shipped under 'freight collect'?

The buyer pays the freight charges upon delivery Signup and view all the answers

Under the 'FAS' shipping term, who bears the cost of loading the goods onto the vessel?

The buyer bears the cost of loading Signup and view all the answers

What must be done to the customer's account when a collection is made on a previously uncollectible account?

Recharge the account and credit accounts receivable. Signup and view all the answers

What are customers' credit balances in accounts receivable classified as?

Current liabilities Signup and view all the answers

How are claims receivable initially measured according to PFRS 9?

At fair value plus transaction costs Signup and view all the answers

What does the 'CIF' shipping term require the buyer to pay?

Cost of goods, insurance, and freight charges Signup and view all the answers

For short-term receivables, how is the fair value typically represented?

Face amount or original invoice amount Signup and view all the answers

What happens to the title and risk of loss under 'ex-ship' shipping terms?

They remain with the seller until goods are unloaded Signup and view all the answers

After initial recognition, how should accounts receivable be measured according to PFRS 9?

At amortized cost Signup and view all the answers

Under the 'freight prepaid' term, who has paid for the freight charges?

The seller has already paid the freight charges Signup and view all the answers

In the case of 'freight collect', who ultimately pays for the freight if goods are shipped?

The buyer pays upon delivery Signup and view all the answers

What term is preferably used in relation to accounts receivable instead of amortized cost?

Net realizable value Signup and view all the answers

When estimating the net realizable value of trade accounts receivable, what is one of the deductions made?

Allowance for freight charge Signup and view all the answers

Which shipping term indicates that ownership and risk are transferred only when the goods are at the buyer’s premises?

FOB destination Signup and view all the answers

Which element is NOT typically considered when determining the initial amount of accounts receivable?

Transaction costs Signup and view all the answers

Why should assets not be carried at above their recoverable amount?

To align with accounting standards Signup and view all the answers

What does FOB destination imply regarding the ownership of goods?

Ownership is transferred to the buyer upon receipt. Signup and view all the answers

When freight is shipped freight collect, who is responsible for the freight charges?

The buyer pays the freight charge upon delivery. Signup and view all the answers

In the accounting for freight charge when the seller ships goods FOB destination but freight collect, how is the freight charge recorded?

Debit freight out and credit allowance for freight charge. Signup and view all the answers

What is the purpose of offering a cash discount to credit customers?

To motivate prompt payment of invoices. Signup and view all the answers

How is a cash discount expressed, such as 5/10, n/30?

5% off if paid in 10 days, total due in 30 days. Signup and view all the answers

Under the gross method of recording credit sales, how are accounts receivable and sales recorded?

At the gross amount of the invoice. Signup and view all the answers

What does freight prepaid indicate about the freight charges?

The seller has already paid the freight charges. Signup and view all the answers

What is the implication of allowing for sales returns in accounting for accounts receivable?

It reduces the total amount of accounts receivable reported. Signup and view all the answers

What is the main purpose of trade discounts?

To encourage trading and increase sales Signup and view all the answers

How often should a physical count of units on hand be made in a perpetual inventory system?

Once a year Signup and view all the answers

What is a key characteristic of cash discounts?

They encourage prompt payment. Signup and view all the answers

What is the main issue with the gross method of recording purchases?

It violates the matching principle. Signup and view all the answers

Which method records purchases at the gross amount of the invoice?

Gross method Signup and view all the answers

What does the net method of recording purchases involve?

Accounting for cash discounts at the time of purchase. Signup and view all the answers

What should be included in the cost of inventories?

Cost of purchase Signup and view all the answers

Why do most entities prefer using the gross method despite its theoretical issues?

It is more convenient for bookkeeping. Signup and view all the answers

Study Notes

Trade Receivables

Claims from sales of merchandise or services
Examples: accounts receivable, notes receivable
Accounts receivable are sales of goods and services not supported by notes (customer accounts, trade debts, trade accounts receivable).
Notes receivable are supported by payment promises
Non-trade receivables arise outside the ordinary course of business (like shareholder advances).
Current assets are expected to be collected within a year; non-current assets for over a year.
Trade receivables are influenced by the operating cycle and the one-year period; nontrade receivables only the one-year period.
Both trade and nontrade receivables that are collectible are shown on the statement of financial position as one line item called trade and other receivables. Details are disclosed in the notes.
Examples of non-trade receivables: advances to shareholders, directors, officers, or employees; advances to affiliates, suppliers; subscription receivables (sometimes shown as deduction from subscribed capital); creditors accounts with debit balances (from overpayment or returns/allowances); special deposits on contract bids (normally non-current); dividend, rent, royalty, and accrued interest receivables (usually current); claims receivable (claims against common carriers for losses, claims for rebates, tax refunds—usually current); customers' credit balances from overpayments, returns, and allowances.

Initial Measurement of Accounts Receivable

Accounts receivable are initially recognized at fair value plus transaction costs.
Fair value is usually the transaction price.
For short-term receivables, fair value is equal to the face amount or original invoice amount.
Cash flows relating to short-term receivables are not normally discounted.
Transaction costs are not usually incurred for accounts receivable.

Subsequent Measurement

Accounts receivable are measured at amortized cost, which is usually the net realizable value.
Net realizable value represents the estimated recoverable amount or cash expected to be collected.
Adjustments that reduce the amount recoverable from the customer are made. Amount recoverable in the ordinary course of business will reduce the amount recoverable.

Allowance for Sales Returns

Some customers return goods requiring a reduction in the amount due from sales.
An estimate of the likely returned goods at year-end is made.

Sales Discount

Businesses often offer cash discounts for prompt payment.
A cash discount is a reduction from the invoice price.
Two main methods:
- Gross Method: Records receivables at gross amount of the invoice
- Net Method: Records receivables at net amount (invoice price minus discount).

Allowance for Sales Discount

If cash discounts are given, estimates are conceptually made of discounts expected to be taken at the end of the period. Example: If receivables are 1,000,000,discountsmaybeestimatedat1,000,000, discounts may be estimated at 1,000,000,discountsmaybeestimatedat50,000.

Accounting for Bad Debts

Two main methods exist for accounting for bad debts
- Allowance Method
- Direct Write-off Method

Recoveries of Accounts Written Off

If collections are made on previously written-off accounts, the procedure is to re-charge the customer's account and possibly the amount previously charged.
Collections are normally handled by debiting cash and crediting accounts receivable.

Doubtful Accounts

Accounts potentially uncollectible at year-end
Accounts that have been previously written-off may be recovered unexpectedly, in which case accounts receivable and the allowance are reversed.

Doubtful Accounts in the Income Statement

If the granting of credit and collection of accounts is handled by the sales manager, doubtful accounts are considered a distribution cost.
If another officer handles it, they are considered an administrative expense.

Methods of Estimating Doubtful Accounts

Aging of Accounts Receivable: Classifies accounts based on due dates (e.g. not due, 1-30 days past due).
Percent of Accounts Receivable: Uses a certain rate multiplied by the open accounts at the end of the period.
Percent of Sales: The amount of sales is multiplied by a certain rate (prior year's bad debt losses divided by prior year's credit sales) .

Inventory

Assets held for sale in the ordinary course of business, in the process of production, or as materials/supplies to be consumed in production.
Types of Inventory in Manufacturing Concerns:
- Finished Goods: Completed products ready for sale.
- Goods in Process: Partially completed products needing further work.
- Raw Materials: Materials used in production, also called Direct Materials.
- Factory Supplies (Indirect Materials): Materials that are not directly used in the production process.
Trading Concerns Inventory: Are goods bought and sold in the same form

Legal Test

To determine if an entity owns goods, applying this test will be used to determine whether or not the inventory should be included or excluded.

Maritime Shipping Terms

FAS (Free Alongside Ship): Seller pays all costs and risks to deliver goods alongside the ship.
CIF (Cost, Insurance, and Freight): Buyer pays a lump sum covering cost, insurance, and freight; seller pays loading costs.
Ex-ship: Seller bears all costs and risks until goods are unloaded; buyer takes responsibility once off the ship.

Accounting for Inventories

Periodic System: Physical count at end of period; unit cost multiplied by quantity to get total inventory value.
Perpetual System: Maintaining records (stock cards) to track inventory inflow and outflow; used for large-value items (like jewelery, cars).

Cost of Inventories

Cost of Purchase: Includes purchase price, import duties, taxes, freight, handling costs.
Cost of Conversion: Includes costs directly related to units produced, like direct labor and a systematic allocation of fixed and variable production overheads.

Cost Formulas

FIFO (First-In, First-Out): Assumes first-purchased goods are first sold; goods remaining are most recently purchased.
Weighted Average: Average cost of all goods available for sale is used to determine the cost of goods sold and ending inventory.

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Description

This quiz focuses on the various aspects of trade receivables, including examples like accounts receivable and notes receivable. It also covers the differences between current and non-current assets and the effects of the operating cycle. Test your knowledge on how these elements are reflected in financial statements.