Chapter 8
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Chapter 8. Reporting and Interpreting Receivables, Bad Debt Expense, and Interest Revenue. Amounts owed by other companies or persons for cash, goods, or services. Open accounts owed to the business by trade customers. Accounts Receivable. Accounts Receivable. Notes Receivable.

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Chapter 8

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Chapter 8

Chapter 8

Reporting andInterpreting Receivables,Bad Debt Expense, andInterest Revenue


Accounts receivable

Amounts owed by other companies or persons for cash, goods, or services.

Open accounts owed to the business by trade customers.

Accounts Receivable

Accounts Receivable


Notes receivable

Notes Receivable

A note receivable is a written contractestablishing the terms by which acompany will receive amounts it is owed.

Companies may convert accountsreceivable balances to notes for customerswho are having difficulty paying their receivables.


Notes receivable1

Term

January 5, 2008

Payee

$1,200

Sixty days

after date I promise to pay to

Principal

Skechers U.S.A., Inc.

the order of

One thousand two hundred ---------------------------------

Dollars

Interest Rate

First National Bank

Payable at

8%

Value received with interest atper annum

Alan Jones

8563

March 6, 2008

No. Due

Jones Athletic Company

Due Date

Notes Receivable


Learning objective 1

Learning Objective 1

Describe the tradeoffs of extending credit.


Pros and cons of extending credit

Extending credit is likely to increasesales, but not without costs:

Increased wage costs to manage receivables

Delayed receiptof cash

Bad debtscosts

Pros and Cons of Extending Credit

Businesses extend credit togenerate additional sales and tomeet the terms offered by competitors.


Learning objective 2

Learning Objective 2

Estimate and report the effects of uncollectible accounts.


Accounts receivable and bad debts

Accounts Receivableand Bad Debts

Bad debtsresult from credit customers who will not pay the business the amountthey owe, regardless of collection efforts.


Accounts receivable and bad debts1

Accounts Receivableand Bad Debts

Bad debts are likely to be discovered inperiods after the credit sale.

If bad debts are not reported until discovered,income is distorted in the periods of sale aswell as in the period of bad debt discovery.


The allowance method of accounting for bad debts

Matching Principle

The Allowance Method of Accounting for Bad Debts

Bad Debt Expense

Record in same accounting period.

Sales Revenue


The allowance method of accounting for bad debts1

The Allowance Method of Accounting for Bad Debts

Most businesses record an estimate ofthe bad debt expensewith an adjustingentry at the end of the accounting period.


Record estimated bad debt expense

Record EstimatedBad Debt Expense

For the year ended December 31, 2005, Skechers U.S.A., Inc., estimated itsbad debt expense to be $2,882,000.

Prepare the adjusting entry.


Record estimated bad debt expense1

Contra asset account

Record EstimatedBad Debt Expense

For the year ended December 31, 2005, Skechers U.S.A., Inc., estimated itsbad debt expense to be $2,882,000.

Prepare the adjusting entry.

Bad Debt Expenseis normally classified as a selling expense and is closed at year-end.


Allowance for doubtful accounts

Amount the businessexpects to collect.

Allowance for Doubtful Accounts

Balance Sheet Disclosure


Remove write off specific customer balances

When it is clear that a specific customer’s account receivable will be uncollectible, the amount should be removed from the Accounts Receivable account and charged to the Allowance for Doubtful Accounts.

Remove (Write Off) Specific Customer Balances


Remove write off specific customer balances1

Skechers’ total write-offs for2005 were $1,729,000.

Prepare a summary journalentry for these write-offs.

Remove (Write Off) Specific Customer Balances


Remove write off specific customer balances2

Remove (Write Off) Specific Customer Balances

Skechers’ total write-offs for2005 were $1,729,000.

Prepare a summary journalentry for these write-offs.


Remove write off specific customer balances3

Remove (Write Off) Specific Customer Balances

Assume that before the write-off, Skechers’ Accounts Receivable balance was $56,000,000 and the Allowance for Doubtful Accountsbalance was $6,043,000.

Let’s see what effect the total write-offs of $1,729,000 had on these accounts.


Remove write off specific customer balances4

Remove (Write Off) Specific Customer Balances

Notice that the total write-offs of $1,729,000 did not change the net accounts receivable value nor did it affect any income statement accounts.


Estimating bad debts

Aging of Accounts Receivable

????

Estimating Bad Debts

Focus is on determining the desired balance in theAllowance for Doubtful Accountson the balance sheet.


Aging schedule

Each customer’s account is aged by separating the total amount owed by each customer into aging categories based on the number of days that have passed since uncollected amounts were first recorded in the account.

Let’s look on the next slide to see an aging of accounts receivable for Skechers (all amounts in thousands).

Aging Schedule


Aging schedule1

Aging Schedule

(in thousands)

Next, based on past experience, the business estimates the percentage of uncollectible accounts in each time category.


Aging schedule2

Aging Schedule

(in thousands)

Now we will multiply these percentages by the appropriate column totals.


Aging schedule3

Aging Schedule

(in thousands)

The column totals are then added to arrive at the total estimate of uncollectible accounts of $7,196.


Aging of accounts receivable

Record the year-end adjusting entry assuming that the Allowance for Doubtful Accounts currently has a $4,314,000 credit balance.

Aging of Accounts Receivable

(in thousands)


Aging of accounts receivable1

Aging of Accounts Receivable

After posting, the Allowance account would look like this . . .


Aging of accounts receivable2

Aging of Accounts Receivable

Notice that the balance after adjustment is equal to the estimate of $7,196,000 based on the aging analysis performed earlier.


Other issues account recoveries

Other Issues – Account Recoveries

Collections of accounts previously written off require that the original write-off entry be reversed before the cash collection is recorded.

Let’s record the entry that Skechers would make if $50,000 is collected that had previously been written off.


Learning objective 3

Learning Objective 3

Compute and report interest on notes receivable.


Notes receivable and interest revenue

Notes Receivable andInterest Revenue

Accounting for notes receivableis similar to accounting foraccounts receivable except for interest.

Accounts receivable do notcharge interest until theybecome overdue, but notesreceivable start charginginterest the day they are created.


Calculating interest

Even for maturities less than 1 year, the rate is annualized.

Number of months out of twelvethat interest period covers.

Calculating Interest


Reporting interest on notes receivable

Reporting Interest onNotes Receivable

On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.

Recordnotereceivable

Record interestand principal received

Accrueinterest

2007 Interest

2008 Interest

11/01/07

12/31/07

10/31/08


Recording notes receivable

Recording Notes Receivable

On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.

On November 1, to record the note:


Accruing interest earned

Accruing Interest Earned

On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.

×

×

$ 2,000

=

$ 100,000

12%

2/12

Interest revenue is $1,000 per month.


Accruing interest earned1

Accruing Interest Earned

On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.

On December 31, to accrue $ 2,000 interest receivable:


Recording interest received and principal at maturity

Recording Interest Receivedand Principal at Maturity

On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.

On October 31, to record $112,000 cash received:


Accounting for uncollectible notes

Accounting for Uncollectible Notes

When the collection of a note receivable is in doubt,a company should record anallowance for doubtful accounts against notes receivable justas is done with accountsreceivable.


Learning objective 4

Learning Objective 4

Compute and interpret the receivables turnover ratio.


Receivables turnover analysis

Receivables TurnoverRatio

Net Credit Sales RevenueAverage Net Trade Receivables

=

Receivables Turnover Analysis

Skechers reported 2005 net credit sales of $1,006,000,000.December 31, 2005, receivables were $134,600,000 andDecember 31, 2004, receivables were $120,400,000.


Receivables turnover analysis1

Receivables TurnoverRatio

Net Credit Sales RevenueAverage Net Trade Receivables

=

$1,006,000,000

($134,600,000 + $120,400,000) ÷ 2

=

Receivables Turnover Analysis

= 7.9 times

This ratio measures how many times average receivables are recorded and collected for the year.


Receivables turnover analysis2

Days to Collect

365 DaysReceivables Turnover Ratio

=

Days to Collect

365 Days7.9

=

= 46.2 Days

Receivables Turnover Analysis

This ratio tells us the average number of daysit takes a company to collect its receivables.


Factoring receivables

Factoring Receivables

When a company desires to quickly convert receivables into cash, the receivables can be sold to a financing company or bank (calledfactoring).


Credit card sales

Companies accept credit cardsto:

To increase sales.

To avoid providing credit directly to customers.

To avoid losses due to bad checks.

To receive payment quicker.

Credit Card Sales

When credit card sales are made, a fee is paid to the credit card company for the service it provides.


Chapter 8 supplement

Chapter 8Supplement

Percentage of Credit Sales Method


Percentage of credit sales

Percentage of Credit Sales

Bad debt percentage is based on actual uncollectible accounts from prior years’credit sales.

Focus is on determining the amount to record on the income statement asBad Debt Expense.


Percentage of credit sales1

Percentage of Credit Sales


Percentage of credit sales2

Percentage of Credit Sales

In the current year Skechers had credit sales of $1,152,800,000. Past experience indicates that bad debts are one-fourth of one percent (.25%) of sales.

What is the estimate of bad debt expense for the year?

$1,152,800,000 × .0025 = $2,882,000

Let’s prepare the adjusting entry.


Percentage of credit sales3

Percentage of Credit Sales


Direct write off method

Direct Write-Off Method

No journal entries are made until a bad debt is discovered. The following journal entry is made to record $1,000 of bad debt expense when a customer account is determined to be uncollectible.

Acceptable for tax purposes,but unacceptable under generally accepted accounting principles.


End of chapter 8

End of Chapter 8


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