What is the theoretical justification of the allowance method as contrasted with the direct write-off method of accounting for bad debts?
The theoretical superiority of the allowance method over the direct write-off method of accounting for bad debts is two-fold. First, since revenue is considered to be recognized at the point of sale on the assumption that the resulting receivables are valid liquid assets merely awaiting collection, periodic income will be overstated to the extent of any receivables that eventually become uncollectible. The proper matching of revenue and expense requires that gross sales in the income statement be partially offset by a charge to bad debt expense that is based on an estimate of the receivables arising from gross sales that will not be converted into cash.
Second, accounts receivable on the balance sheet should be stated at their estimated net realizable value. The allowance method accomplishes this by deducting from gross receivables the allowance for doubtful accounts. The latter is derived from the charges for bad debt expense on the income statement.
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Accounting
- Distinguish between gross profit as a percentage of cost and gross profit as a percentage of sales price.
- What are the major uses of the gross profit method?
- Under what circumstances is relative sales value an appropriate basis for determining the price assigned to inventory?
- What approaches may be employed in applying the LCNRV procedure? Which approach is normally used and why?
- Why are inventories valued at the lower-of-cost-or-net realizable value (LCNRV)? What are the arguments against the use of the LCNRV method of valuing inventories?
- Why will the traditional LIFO inventory costing method and the dollar-value LIFO inventory costing method produce different inventory valuations if the composition of the inventory base changes?
- What advantage does the dollar-value method have over the specific goods approach of LIFO inventory valuation?
- What is the dollar-value method of LIFO inventory valuation?
- FIFO, average-cost, and LIFO methods are often used instead of specific identification for inventory valuation purposes. Compare these methods with the specific identification method, discussing the theoretical propriety of each method in the determination of income and asset valuation.
- Distinguish between product costs and period costs as they relate to inventory.
- Define "cost" as applied to the valuation of inventories.
- Where, if at all, should the following items be classified on a balance sheet?
- What is a repurchase agreement (product financing) arrangement? How should a product repurchase agreement be reported in the financial statements?
- What is the difference between a perpetual inventory and a physical inventory? If a company maintains a perpetual inventory, should its physical inventory at any date be equal to the amount indicated by the perpetual inventory records? Why?
- In what ways are the inventory accounts of a retailing company different from those of a manufacturing company?
- What is the fair value option? Where do companies that elect the fair value option report unrealized holding gains and losses?
- Indicate how the percentage-of-receivables method, based on an ageing schedule, accomplishes the objectives of the allowance method of accounting for bad debts. What other methods, besides an ageing analysis, can be used for estimating uncollectible accounts?
- What are the basic problems that occur in the valuation of accounts receivable?
- 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?
- What are the reasons that a company gives trade discounts? Why are trade discounts not recorded in accounts like cash discounts?
- What may be included under the heading of "cash"?
- State the generally accepted accounting principle applicable to balance sheet valuation of each of the following assets.
- Where should the following items be shown on the balance sheet, if shown at all?
- In what section of the balance sheet should the following items appear, and what balance sheet terminology would you use?
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