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Multiple Choice
In the context of receivables, how does the value of collateral or a down payment affect the accounting or risk assessment of a receivable?
A
It requires the receivable to be classified as a note receivable.
B
It increases the interest revenue recognized on the receivable.
C
It reduces the credit risk associated with the receivable.
D
It eliminates the need to estimate bad debt expense.
Verified step by step guidance
1
Understand the concept of receivables: Receivables represent amounts owed to a company by customers or other parties. They are classified as either accounts receivable (short-term) or notes receivable (long-term, often with interest).
Recognize the role of collateral or down payment: Collateral is an asset pledged by the borrower to secure the receivable, while a down payment is an upfront payment made by the borrower. Both serve to reduce the lender's exposure to risk.
Analyze the impact on credit risk: Collateral or a down payment reduces the credit risk associated with the receivable because it provides a safety net for the lender in case the borrower defaults. This makes the receivable less risky to hold.
Clarify why bad debt expense estimation is still necessary: Even with collateral or a down payment, there is still a possibility of default. Therefore, companies must continue to estimate bad debt expense to account for potential losses.
Understand why interest revenue is unaffected: The presence of collateral or a down payment does not directly increase the interest revenue recognized on the receivable. Interest revenue is determined by the terms of the note or agreement, not the presence of collateral.