Chapter 5. Receivables and Sales. Credit sales. Are common for large business transactions in which buyers don’t have sufficient cash available or where credit cards cannot be used because the transaction amount exceeds typical credit card limits.
Receivables and Sales
Recognition of Accounts Receivable
Jay’s Dental charges $500 for teeth whitening. Dee Kay decides to take advantage of the service, has her teeth whitened on March 1, but doesn’t pay cash at the time of service. Dee promises to pay the $500 whitening fee to Jay by March 31. Jay makes the following entry at the time of the cleaning.
Represent a reduction in the listed price of a product or service.
Companies don’t recognize trade discounts directly when recording a transaction. Instead,they recognize trade discounts indirectly by recording the sale at the discounted price.
Let’s go back to Jay’s Dental, which typically charges $500 for teeth whitening. Jay offers a 20% discount on teeth whitening to any of his regular patients.
Jay records the following entry at the time he collects cash from Dee.
Notice that there is no indication in recording the transaction that the customer does not take the sales discount. This is the typical entry to record a cash collection on account when no sales discounts are involved.
Sales Return pay, which is not within the 10-day discount period
If a customer returns a product it is sales return. After a sales return,
we reduce the customer’s account balance if the sale was on account or
we issue a cash refund if the sale was for cash.
If a customer does not return a product, but the seller reduces the customer’s balance owed or provides at least a partial refund because of some deficiency in the company’s product or service, we call that a sales allowance.Sales Return and Allowances
On March 5, after Dee gets her teeth cleaned but before she pays, she notices that another local dentist is offering the same procedure for $350.Dee brings this to Jay’s attention and because Jay’s policy is to match any competitor’s pricing, he offers to reduce Dee’s account balance by $50. Jay records the following sales allowance entry.
Valuation of Accounts Receivable
Should companies sell goods and services to their customers on account, or should they accept only cash payment at the time of purchase?
The upside, allowing customers the
ability to purchase on account and
pay cash later boosts sales.
The downside of extending credit to
customers is that not all customers
will pay fully on their accounts
Involves recording an adjusting entry at the end of each period to allow for the possibility of future uncollectible accounts.
The adjusting entry has the effect of
reducing accounts receivable by an estimate of the amount we don’t expect to collect and
recording an expense to reflect the cost of offering credit to customers.
Kimzeyspecializes in emergency outpatient care. It doesn’t verify the patient’s health insurance, It understands that a high proportion of fees for emergency care provided will not be collected. In 2010, it bills customers $50 million. By the end of the year, $20 million remains due from customers. Of this amount, it estimates that 30% is likely to be uncollected. The year-end adjusting entry to allow for these future uncollectible accounts is as follows:
After we adjust for future uncollectible accounts, the accounts receivable portion of Kimzey’s year-end balance sheet appears below
On February 23, 2011, Kimzey receives notice that one of its former patients, Bruce, has filed for bankruptcy. He believes it is unlikely Bruce will pay his account of $4,000. Remember, Kimzey previously allowed for the likelihood that some of its customers would not pay. Now it knows a specific customer will not pay, it can adjust the allowance and reduce the accounts receivable. Kimzey makes the following entry.
Later in 2011, on September 8, Bruce’s bankruptcy proceedings are complete. Kimzey had expected to receive none of the $4,000 Bruce owed. After liquidating all assets, Bruce is able to pay each of his creditors 25% of the amount due them. Kimzey records the following two entries.
Total accounts written off by Kimzey during 2011 equaled $5 million but that $1 million of this amount was collected by the end of the year. The timeline of events related to accounts receivable during 2010 and 2011 is this:(1) Accounts receivable total $20 million at the end of 2010.(2) Made an adjusting entry at the end of 2010 for estimated bad debts of $6
million.(3) Actual accounts wrote off as uncollectible in 2011 total $5 million.(4) Of the $5 million written off, $1 million later appears receivable.(5) Received $1 million cash for the accounts re-established in (4).
At the end of 2011, Kimzey must once again estimate uncollectible accounts and make a year-end adjusting entry. Suppose that in 2011 it bills customers for services $80 million, and $30 million are still receivable at the end of the year. Of $30 million receivable, it estimates 30% will not be collected. For what amount would it record the year-end adjusting entry for bad debts in 2011?.
The current balance of the allowance account is
Based on all available information at the end of 2011, Kimzey estimates that the allowance for uncollectible accounts should be $9 million. Allowance account needs to increase from its current balance of $2 million credit to the estimated ending balance of $9 million credit. It can accomplish this by adjusting the account for $7 million as follows:
KimzeyMedical Clinic – How aging of accounts receivable can be used to estimate uncollectible accounts. Recall that accounts receivable at the end of 2011 totaled $30 million. Below image shows its accounts receivable aging schedule at the end of 2011.
Direct Write-Off Method
Suppose a company provides services for $10,000 on account in 2010, but makes no allowance for uncollectible accounts at the end of the year. On September 17, 2011, $2,000 is considered uncollectible. The company records the write-off as follows.
Assume that by the end of 2010 we estimate $2,000 of accounts receivable won’t be collected. Also assume that our estimate of future bad debts turns out to be correct, and actual bad debts in 2011 total $2,000.
It shows the number of times during a year that the average accounts receivable balance is collected.
Receivables turnover ratio =
Average accounts receivable
The average collection period is another way to express the same measure. It shows the approximate number of days the average accounts receivable balance is outstanding.
Average collection period=
Receivables turnover ratio
Net credit sales are $400,000 for the year and the average accounts receivable balance is $40,000. We could say the turnover ratio is 10, or average receivables were collected 10 times during the year. If the turnover is 10 times a year (365 days), then the average balance is collected every 36.5 days.
February 1, 2010, Kimzeyhas a patient, Justin Payne, who has a severely past due account receivable of $10,000. In place of the account receivable, it accepts a six-month, 12% promissory note from him. An example of a typical note receivable is shown below. It records the note as follows.
Kimzeyissued a six-month, 12% promissory note. It will charge Justin Payne one-half year of interest. Interest on its note receivable is calculated as follows.
We record the collection of notes receivable the same way as a collection of accounts receivable, except we record interest earned as interest revenue in the income statement.
August 1, 2010, the maturity date, Justin repays the note and interest in full as promised. Kimzey will record the following entry.
Remember, interest is earned as time goes by, so Kimzey earns two months’ interest ($200) in 2010 even though it won’t collect it until 2011. On May 1, 2011, the maturity date, It records the collection of the note receivable and interest receivable as well as the revenue related to four months’ interest earned in 2011.
On May 1, 2011, it has received the note receivable recorded on November 1, 2010, and the interest receivable recorded on December 31, 2010, and has eliminated their balances. The remaining four months’ interest occurs in 2011 and it recognizes as revenue then. Interest receivable from its six-month, $10,000, 12% note is $100 per month (= $10,000 x 12% x 1/12).
Percentage of Credit Sales Method
Based on the estimate of bad
debts on a balance sheet
Credit sales method
Based on the estimate of bad
debts on a income statement
Balance sheet method
Income statement method