Receivables and Bad Debt: every key term you need (+ practice quiz)
25 flashcard terms for Financial Accounting Topic 5, written to match the course framework. Study them here, then drill them as interactive flashcards, or test yourself with the 15-question quiz — free, no account needed.
Amounts customers owe from credit sales in the ordinary course of business. They are current assets, carry no formal interest, and are usually collected within the firm's stated credit period.
Nontrade receivable
A claim arising outside normal sales activity, such as a loan to an employee, a tax refund due or interest owed by a bank. It is reported separately when the amount is significant.
Note receivable
A written promise from a debtor to pay a stated principal on a stated date, normally with interest. The formal instrument gives stronger legal standing than an ordinary open account.
Promissory note
The instrument behind a note receivable, naming maker, payee, principal, interest rate and maturity date. Its terms determine how much interest accrues and when collection may be enforced.
Maturity value
Principal plus all interest due at the end of a note's term. It is what the maker must pay on the due date, and it is the amount pursued if the note is dishonored.
Simple interest computation
Interest equals principal multiplied by the annual rate multiplied by the fraction of a year the note is outstanding. Careful conversion of days or months to a fraction of a year is the usual trap.
Dishonored note
A note the maker fails to pay at maturity. The balance including accrued interest is transferred back into an open receivable so collection efforts continue against a still valid claim.
Bad debt expense
The estimated cost of credit sales that will never be collected. Recognizing it in the period of sale rather than the period of default keeps the cost matched with the revenue it produced.
Allowance for doubtful accounts
A contra account that reduces gross receivables to the amount expected to be collected. Its credit balance is an estimate of future defaults, not a record of any specific customer.
Allowance method
Estimate uncollectible amounts at period end and record expense with a credit to the allowance. It is required whenever bad debts are material because it respects expense recognition timing.
Direct write-off method
Expense is recorded only when a specific account is judged worthless. It is simple but delays the cost into a later period, so it is acceptable only when the amounts are immaterial.
Percentage-of-sales method
A share of credit sales for the period is charged to expense, added on top of whatever allowance balance already exists. This income statement approach targets the expense figure directly.
Aging of receivables method
Balances are grouped by how overdue they are and each band carries a higher default rate. The computed total becomes the required ending allowance, so the entry is the amount needed to reach it.
Aging schedule
The supporting table sorting each customer balance into current, thirty days past due, sixty days past due and older columns. It doubles as a collection management tool for the credit department.
Write-off entry
Debit the allowance and credit the customer's receivable when an account is deemed uncollectible. Because both accounts fall together, the carrying amount and net income are unchanged.
Recovery of a written-off account
Reinstate the receivable by reversing the earlier write-off, then record the collection normally. Two steps are used so the customer's payment history remains visible in the records.
Carrying amount of receivables
Gross accounts receivable less the allowance, representing the cash the firm expects to collect. This is the figure that belongs in current assets and in liquidity ratios.
Accounts receivable turnover
Net credit sales divided by average receivables, showing how many times the balance is collected per year. Falling turnover often precedes a rise in write-offs.
Days sales outstanding
Days in the year divided by receivable turnover, giving the average collection period. Comparing it with the stated credit terms shows whether customers are respecting those terms.
Credit policy
The rules governing who may buy on account, on what terms and up to what limit. Loosening it lifts sales but raises expected defaults, which is the core trade-off in receivable management.
Factoring receivables
Selling receivables to a finance company for immediate cash at a discount. It converts a slow asset into cash but sacrifices part of the balance and may signal funding pressure.
Pledging receivables
Using receivables as collateral for a loan while retaining ownership and collection duty. The arrangement stays on the books and must be disclosed because the assets are encumbered.
Credit card sales
The card company assumes collection risk and remits the sale less a processing fee. The seller records the fee as an expense and treats the transaction as essentially a cash sale.
Concentration of credit risk
Exposure when a few customers or one industry owe most of the balance. It must be disclosed, because a single failure could wipe out far more than the average default rate suggests.
Segregation of duties over collections
The person recording customer balances should not also handle incoming cash. Separating custody from record keeping is the main control preventing theft hidden by a false write-off.