Receivables

Chapter 9

Receivables
Refers to amounts due from individuals

and companies - expected to be collected in cash Frequently classified as: Accounts receivable Notes receivable Other receivables
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Accounts Receivable
Amounts owed by customers on account Result from the sale of goods/services Expected to be collected within 30-60

days Most significant type of claim held by company Often called trade receivables.
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Notes Receivable
Represent claims for which formal instruments of credit are issued as evidence of debt.

Notes Receivable

Credit instrument normally requires: payment of interest extends for time periods of 60-90 days or longer
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Notes Receivable
Result from sale of goods and services

Often called trade receivables

Give holder a stronger legal claim to

assets than accounts receivable Negotiable instruments and may be transferred to another party by endorsement
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Trade Receivable
Notes and accounts receivables that result from sales transactions.

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Other Receivables
Nontrade including: interest receivable loans to company officers advances to employees income taxes refundable

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Accounts Receivable
Are recorded at point of sale of merchandise on account.
Accounts Receivable 100 Sales 100

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Subsidiary Accounts Receivable Ledger

Subsidiary ledger is a group of accounts that

share a common characteristic. The subsidiary ledger for accounts receivable provides the details that support the accounts receivable control account in the general ledger.

Objective 1 Design internal controls for receivables.

Establishing Internal Control

What are some controls over accounts

receivable? Control over mail receipts

Approval for write-off

Separation of duties

Objective 2 Use the allowance method to account for uncollectibles and estimate uncollectibles by the percent of sales and aging approaches.

The Credit Department

Companies grant credit to customers in

order to increase sales. The credit department evaluates customers who apply for credit cards.

Cash (Net) Realizable Value

The net amount expected to be

collected in cash Excludes amounts the company estimates it will not collect
Keeps Receivables from Being Overstated on the Balance Sheet.
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Uncollectible Accounts Expense

Allowance method

Direct write-off method

Allowance Method
The matching principle dictates that the

bad debt expense must be recorded in the period when the related revenue is earned. There are many acceptable methods to estimate uncollectible accounts.

Allowance Method
Nov 9 Dec 31 End of Fiscal Year Apr 30

The Allowance Method has two advantages: 1. Expenses are matched with Prepare adjusting entry revenues in the same accounting period based on estimatesare reported on 2. Accounts Receivables balance sheet at the amount of cash expected to be collected

Allowance Method
Operating expense
GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT

Dec 31 Uncollectible Accounts Expense Allowance for Uncollectible Accounts

To estimate bad debts for period

Contra-asset account

Allowance Method
Gross Accounts Receivable reported on balance sheet at its amount net realizable value

Accounts Receivable Estimated Allowance for Doubtful Accounts

uncollectible

$750,000 (3,500) $746,500

Expected to be collected

Methods for Estimating Uncollectible Expense

Percentage of Sales

Aging of Receivables

Percentage of Sales
This is also called the income statement

approach. It is based on prior experience of the business. It is computed as a percentage of credit sales. It ignores the current balance of the allowance account. The percentage used is adjusted as needed to reflect collection experience.

Percentage of Sales Example

The credit department of Anas Boutique

estimates (based on prior experience) that 1% of net credit sales are uncollectible. Net credit sales for the year just ended were $500,000. What is the adjusting entry? $500,000 1% = $5,000

Percentage of Sales Example

Dec 31, 20xx Uncollectible Account Expense 5,000 Allowance for Uncollectible Accounts 5,000 Recorded expense for the year

Percentage of Sales Example

What is the effect of this adjusting entry?

Decrease in Net Income

Decrease in net Accounts Receivable

Aging of Accounts Receivable

This approach is also called the balance

sheet approach because it focuses on accounts receivable. Individual accounts receivable from specific customers are analyzed according to the length of time they remain outstanding.

Aging of Receivables Example

Assume that International Hospitals

past collection experience indicates the following: Length of time % uncollectible 1-30 days 2.0 31-60 days 3.0 61-90 days 5.0 90 + days 8.0

Aging of Receivables Example

Length 1-30 31-60 61-90 90 + Total Amount $1,900,000 1,000,000 700,000 500,000 $4,100,000
Accounts Receivable

% 2 3 5 8

$ 38,000 30,000 35,000 40,000 $143,000

Allowance for Uncollectible Accounts

Aging of Receivables Example

The allowance account is adjusted to this

$143,000 balance: Assume that the account currently has a credit balance of $100,000. What is the adjustment?

Aging of Receivables
Uncollectible Account Expense 43,000 Allowance for Uncollectible Accounts 43,000 To record allowance for uncollectibles

What if the account had a debit balance of $1,000?

Aging of Receivables
Allowance for Uncollectible Adjustment 1,000 144,000 Adjusted balance 143,000

Comparing the Percentage of Sales and Aging Methods

Allowance Method
Percent of Sales Method

Aging of Accounts Receivable Method

Adjusts Allowance for Uncollectible Accounts TO

Adjusts Allowance for Uncollectible Accounts

BY Amount of UNCOLLECTIBLE ACCOUNT EXPENSE

Amount of
UNCOLLECTIBLE ACCOUNTS RECEIVABLE

Writing Off Uncollectible Accounts

What happens when it becomes apparent

that an account will not be collected? It must be written off. How? Debit Allowance for Uncollectible Accounts. Credit Accounts Receivable.

Recoveries
How is the collection of a previously written-

off account recorded? Debit Accounts Receivable (to reinstate the account). Credit Allowance for Uncollectible Accounts. Debit Cash. Credit Accounts Receivable (to record the collection).

Objective 3

Use the direct write-off method to account for uncollectibles.

Direct Write-Off Method

Using this method, an account is written

off only when it becomes uncollectible. No allowance account is created. This method is simple to use. The balance sheet is overstated. The income statement is understated.

Direct Write-Off Method

Nov 9
Sale Recorded
Expenses should be matched with revenues in same accounting period. Bad debts arising from 2006 sales should be treated as 2006 expenses. The direct write-off method violates the matching principle. This method is acceptable only when uncollectibles are very low

Dec 31 End of Fiscal Year

Apr 30
Expense Recorded

Credit Card and Bankcard Sales

These save retailers the cost of a credit

department. The retailer is required to pay a fee (called a discount) for usage.

Credit Card and Bankcard Sales

How would Anas Boutique record a $100

credit card sale with a 2% service charge?

Accounts Receivable (credit card) Credit Card Discount Sales Revenue To record a credit card sale of $100 less a 2% service charge fee 98

2
100

Debit Card Sales

Using a debit card is like paying with cash.

Objective 4 Account for notes receivable.

Notes Receivable: an Overview

A note receivable may arise from a sale or

may be given in settlement of an account receivable. The maker pays the payee the maturity value. The maturity value includes principal plus interest.

Maker
Is the party in a promissory note who is making the promise to pay.

Payee
Is the party to whom payment of a promissory note is to be made.

Notes Receivable: an Overview

Promissory Note
$10,000.00 Nov. 30, 2004 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100DOLLARS ON FEBRUARY 28, 2005

Payee Plus interest at the annual rate of 10 percent. __________

Notes Receivable: an Overview

Promissory Note
$10,000.00 Nov. 30, 20x4 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100DOLLARS ON FEBRUARY 28, 20x5 Plus interest at the annual rate of 10 percent. __________ Principal

Notes Receivable: an Overview

Promissory Note
$10,000.00 Nov. 30, 20x4 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100DOLLARS ON FEBRUARY 28, 20x5 Plus interest at the annual rate of 10 percent. __________

Interest rate

Date of issue

Notes Receivable: an Overview

Promissory Note
$10,000.00 Nov. 30, 20x4 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100DOLLARS ON FEBRUARY 28, 20x5 Plus interest at the annual rate of 10 percent. __________

Maturity date

Identifying a Notes Maturity Date

When the period is given in days

the maturity date is determined by counting

the days from the date of issue. The date the note was issued is omitted. The maturity date is counted.

Formula for Interest

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Computing Interest on a Note

Principal Rate Time = Interest Compute interest on the note due to Popular Bank. Principal: $10,000 Interest: 10% Time: December 1, 20x4, to February 28, 20x5 $10,000 10% 90 360 = $250

Notes Receivable
A note is recorded at

face value without interest added. Notes receivable are reported at cash (net) realizable value. A note is honored when it is paid in full at maturity.
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Recording Notes Receivable

Assume the accounting period ended

December 31. How much interest was earned by the bank as of December 31? $10,000 10% (31 360) = $86.11

Recording Notes Receivable

December 31 Interest Receivable 86.11 Interest Revenue To accrue interest on the note

86.11

Recording Notes Receivable

How does the bank record the collection

at maturity?
February 28 Cash Note Receivable Interest Receivable Interest Revenue Record interest on note

10,250.00
10,000.00 86.11 163.89

Dishonored Notes Receivable

If the maker of the note fails to pay the

maturity value to the new payee, then the original payee legally must pay the bank the amount due.

Objective 5 Report receivables on the balance sheet.

Reporting Receivables
Some companies report a single amount for

its current receivables in the body of the balance sheet. They use a note to the financial statements to give more details.

Objective 6

Use the acid-test ratio and days sales in receivables to evaluate a company.

Acid-Test Ratio
This is a stringent test of liquidity.
It measures the entitys ability to pay its

current liabilities immediately.

Acid-test ratio = (Cash + Short-term investments + Net current receivables) Total current liabilities

Days Sales in Receivables

It is a measure of the time it takes to

collect receivables. A smaller number indicates a quick conversion to cash.

Days Sales in Receivables

One days sales = Net sales 365 days

Days sales in average accounts receivable = Average net accounts receivable One days sales

End of Chapter 9