Interpreting the Allowance Method for Accounts Receivable

M6-13.  Interpreting the Allowance Method for Accounts Receivable

Ans. a) The company Bismark Corp maintains an allowance account to show the amounts it is doubtful of receiving as accounts receivable. Maintaining an allowance account  presents a more realistic picture of how much of the accounts receivable will be actually received. The company knows from past experience that a few customers will not be able to pay the full amount they owe to the company when the time is due. Hence, there is a risk in the collectability of accounts receivable. This collectability risk is crucial to the analysis of accounts receivable and therefore to the financial accounting of the company.

b) Accounts receivable, net refers to the amounts to the company from customers arising fro the sale of products and services on credit (net refers to the subtraction of uncollectible amounts). The balance sheet presentation of the accounts receivable is intended to show the total receivables less the allowance for uncollectible accounts. A company is expected to estimate the dollar amount of uncollectible accounts and reduce it from the total accounts receivable to show a better estimate of the actual receivables.

c) Accrual accounting requires that revenue be recorded when realized or earned. Earned means that the seller has performed its duties under the terms of the sales agreement and the title of the product sold has been passed on to the buyer with no right of return or other contingencies. The customer’s debt is treated as accounts receivable if the company has sent an invoice for the goods or services to the customer. A company adds all accounts receivables invoiced during an accounting period as a credit, or increase, on the company’s income statement. Similarly it is important to record any estimated amount on uncollectible accounts. This requires an analysis of receivables as of the balance sheet date. Based on historical data, uncollectible percentages are applied to each account, with higher percentage on older accounts. The result is a dollar amount for the allowance for uncollectible accounts at the balance sheet date.

E6-21. Comparing and preparing PPE turnover for 2 companies.

a) PPE Turnover = Sales/Average PPE Assets, net

PPE Turnover for Intel Corporation for 2012= $53,341/(($27,983 + $23,627)/2)= 2.07

PPE Turnover for Texas Instruments for 2012= $12,825/(($3,912+$4,428)/2)= 3.08

Texas Instruments has a higher PPET than Intel Corporation. This means that Texas Instruments is earning higher sales revenue for every dollar of fixed asset it owns than Intel Corp. A higher PPET generally increases profitability as the company avoids asset-carrying costs and the freed up assets can generate operating cash flow.

b) PPE Turnover is lower for capital-intensive manufacturing companies like these than it is for knowledge-based industries. As companies need long term operating assets, managers usually try to maximize throughput to reduce unit costs. A company can improve asset-turnover ratio by increasing sales. Also, many companies form alliances and are designed to spread ownership of assets among many users. The focus should be identify underutilized assets and increase capital utilization. The company may sell assets that they don’t use as they do not produce any income. Computerizing orders, inventory and billing will improve cash flow. This will show up in sales figures and improve asset-turnover ratio.

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