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Financial Accounting: Tools for Business Decision Making, 3rd Ed. ELS Kimmel, Weygandt, Kieso Chapter 8 Chapter 8 Reporting and Analyzing Receivables After studying Chapter 8, you should be able to : Identify the different types of receivables.

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chapter 8 reporting and analyzing receivables
Chapter 8Reporting and Analyzing Receivables

After studying Chapter 8, you should be able to:

  • Identify the different types of receivables.
  • Explain how accounts receivable are recognized in the accounts.
  • Describe the methods used to account for bad debts.
  • Compute the interest on notes receivable.
  • Describe the entries to record the disposition of notes receivable.
chapter 8 reporting and analyzing receivables4
Chapter 8Reporting and Analyzing Receivables

After studying Chapter 8, you should be able to:

  • Explain the statement presentation of receivables.
  • Describe the principles of sound accounts receivable management.
  • Identify ratios to analyze a company\'s receivables.
  • Describe methods to accelerate the receipt of cash from receivables.
receivables
Receivables...
  • Amounts due from individuals and companies - expected to be collected in cash.
  • Frequently classified as:
    • Accounts receivable
    • Notes receivable
    • Other receivables
receivables differ depending on
Receivables Differ Depending On...
  • Industry
  • Time of year
  • Whether the company extends long-term financing
  • Credit policies
accounts receivable
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.
problems with accounts receivable
Problems with Accounts Receivable
  • Recognizing accounts receivable.
  • Valuing accounts receivable.
accounts receivables
Accounts Receivables...
  • Are reduced as a result of:
    • Sales discounts
    • Sales returns and allowances
slide10

Notes Receivable...

Represent claims for which formal instruments of credit are issued as evidence of debt.

2004

other receivables
Other Receivables

Nontrade including:

  • interest receivable
  • loans to company officers
  • advances to employees
  • income taxes refundable
accounts receivable12
Accounts Receivable...

Are recorded when service is provided or at point of sale of merchandise on account.

Accounts Receivable 100

Sales 100

bad debts expense
Bad Debts Expense...

Is an expense to record estimated uncollectible receivables.

Keeps expenses from being understated

on the income statement and accounts

receivables from being overstated on the

balance sheet.

2 methods for accounting for uncollectible accounts
2 Methods for Accounting for Uncollectible Accounts
  • The Direct Write-off Method
  • The Allowance Method
direct write off method

Bad debt expense will show only actual losses.

Accounts receivable will be reported at gross amount.

Direct Write-off Method
  • Bad debt losses are not estimated.
  • No allowance account is used.
  • Accounts are written off when determined uncollectible as follows:

Bad Debts Expense 200

Accounts Receivable--M. E. Doran 200

direct write off method issue
Direct Write-off Method Issue

No attempt is made to match bad debts expense to sales revenue.

allowance method
Allowance Method
  • Uncollectible accounts receivable are estimated and matched against sales in the same accounting period in which the sales occurred.
  • Uncollectible accounts receivable may be estimated using:
    • Percentage of sales
    • Aging of accounts receivable
recording estimated uncollectibles
Recording Estimated Uncollectibles

Hampton Furniture has credit sales of $1,200,000, of which $200,000 remains uncollected. The credit manager estimates $12,000 will prove uncollectible.

Bad Debts Expense 12,000

Allowance for Doubtful

Accounts 12,000

recording estimated uncollectibles19

Allowance for Doubtful Accounts

Accounts Receivable

Jan 1 Bal 200,000

Jan 1 Bal 12,000

Recording Estimated Uncollectibles

Bad Debts Expense 12,000

Allowance for Doubtful

Accounts 12,000

slide20

Cash (Net) Realizable Value...

  • Is 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.

slide21

HAMPTON FURNITURE

Balance Sheet (partial)

Cash (net) Realizable Value

Current assets

Cash $ 14,800

Accounts receivable $200,000

Less: Allowance for doubtful accounts 12,000 188,000

slide22

HAMPTON FURNITURE

Balance Sheet (partial)

Current assets

Cash $ 14,800

Accounts receivable $200,000

Less: Allowance for doubtful accounts 12,000 188,000

Merchandise Inventory 310,000

Prepaid Expense 25,000

Total current assets $537,800

write off of an uncollectible account
Write-off of an Uncollectible Account

The vice president of finance authorizes a write-off of $500 owed by R.A. Ware.

Allowance for Doubtful

Accounts 500

Accounts Receivable-Ware 500

write off of an uncollectible account24

Allowance for Doubtful Accounts

Accounts Receivable

Jan 1 Bal 200,000

Mar 1 500

Mar 1 500

Jan 1 Bal 12,000

Mar 1 Bal 199,500

Mar 1 Bal 11,500

Write-off of an Uncollectible Account

Allowance for Doubtful

Accounts 500

Accounts Receivable-Ware 500

slide25

Before Write-off

Cash Realizable Value

Cash Realizable Value

Current assets

Cash $ 14,800

Accounts receivable $200,000

Less: Allowance for doubtful accounts 12,000 188,000

After Write-off

Current assets

Cash $ 14,800

Accounts receivable $199,500

Less: Allowance for doubtful accounts 11,500 188,000

recovery of an uncollectible account
Recovery of an Uncollectible Account

Accounts Receivable-Ware 500 Allowance for Doubtful

Accounts 500

Cash 500

Accounts Receivable 500

percentage of receivables
Percentage of Receivables...

Management establishes a percentage relationship between the amount of receivables and the expected losses from uncollectible accounts.

aging of accounts receivable
Aging of Accounts Receivable

The analysis of customer balances by the length of time they have been unpaid. The longer a debt is outstanding the less likely it is to be paid.

slide29

Trade Receivables...

Notes and accounts receivables that result from sales transactions.

notes receivable
Notes Receivable...
  • Credit which is extended by use of a formal instrument.
slide31

Notes Receivable...

Credit instrument normally requires:

  • payment of interest
  • extends for time periods of 60-90 days or longer.
notes receivable32
Are often accepted from customers who need to extend payment of an account receivable.

Are often required from high-risk customers.

Notes Receivable...
slide33

Notes Receivable...

Represent claims for which formal instruments of credit are issued as evidence of debt.

2004

maker
Maker

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

Payee

Payee

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

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

slide36

1,000 x .12 x 12 months/12months

1,000 x .12 x 1 month/12months1,000 x .12 x 3 months/12months1,000 x .12 x 6 months/12months1,000 x .12 x 9 months/12months

Interest rate specified on a note is an annual rate of interest.Prorate for shorter times periods.

slide37

Interest rate specified on a note is an annual rate of interest.

Time factor is often divided by 360 days1,000 x .12 x 360 days/360 days

1,000 x .12 x 27 days/360 days1,000 x .12 x 46 days/360 days1,000 x .12 x 162 days/360 days1,000 x .12 x 265 days/360 days

notes receivable38
Notes Receivable...
  • are recorded at face value.
  • are reported at cash (net) realizable value.
  • are honored when paid in full at maturity.
  • are dishonored when not paid in full at maturity.
notes receivable39
Notes Receivable...
  • Interest revenue is recorded when the note is paid.
  • If interim financial statements are prepared, interest on notes receivable is accrued.
notes receivable40
Notes Receivable...
  • Each type of receivables should be identified in the balance sheet or in the notes to the financial statements.
  • Short-term receivables are reported in the current asset section of the balance sheet below short-term investments.
  • The gross amount of receivables and the allowance for doubtful accounts should be reported.
notes receivable41
Notes Receivable...
  • Notes receivable are listed before accounts receivable because notes are more easily converted to cash.
  • Bad debts expense is reported as a selling expense in the income statement.
  • Interest revenue is shown under other revenues and gains in the nonoperating section of the income statement.
managing receivables
Managing Receivables
  • Determine to whom to extend credit.
  • Establish a payment period.
  • Monitor collections.
  • Evaluate receivables balance.
  • Accelerate cash receipts from receivables when necessary.
extending credit
Extending Credit
  • Risky customers might be required to provide letters of credit or bank guarantees.
  • Risky customers might be required to pay cash on delivery (COD).
  • Ask potential customers for references from banks and suppliers and check the references.
  • Periodically check financial health of continuing customers.
payment period
Payment Period
  • Determine a required payment period and communicate that policy to customers.
  • Make sure company\'s payment period is consistent with that of competitors.
monitoring collections
Monitoring Collections
  • Calculate company’s credit risk ratio.
  • Prepare accounts receivable aging schedule at least monthly.
  • Pursue problem accounts with:
    • phone calls
    • letters
    • legal action if necessary.
concentration of credit risk
Concentration of Credit Risk

Is there a threat of nonpayment from a single customer or class of customers that could adversely affect the financial health of the company.

evaluating the receivables balance
Evaluating the Receivables Balance
  • Liquidity is measured by how quickly certain assets can be converted into cash.
  • The receivables turnover ratio measures the number of times, on average, receivables are collected during the period.
receivables turnover ratio
Receivables Turnover Ratio=

Net Credit Sales

Average Net Receivables

Is a measure of the liquidity

of receivables.

average collection period
Average Collection Period=

365 days

Receivables Turnover Ratio

Is the average amount of time that a receivable is outstanding

accelerating cash receipts
Accelerating Cash Receipts

Waiting for the normal collection process cost money.

accelerating cash receipts51
Accelerating Cash Receipts

A bird in the hand is worth two in the bush.

companies sell receivables
Companies Sell Receivables
  • They get more sales if they provide financing to customers.
    • General Motors Acceptance Corporation
    • Ford Motor Credit Corporation
  • They may be the only reasonable source of cash.
  • Billing and collection are often time-consuming and costly.
factor
Factor...

Is a finance company or bank that buys receivables from businesses for a fee and then collects payments directly from the customers.

expense associated with selling receivables
Expense Associated with Selling Receivables
  • If a company usually sells its receivables, the service charge expense is recorded as a selling expense.
  • However, if receivables are sold infrequently the fee may be reported under other expenses and losses in the income statement.
credit card
Credit Card

A common type of credit card is a national credit card such as:

  • Visa
  • Master Card
  • American Express
credit card56
Credit Card

Three parties are involved when national credit cards are used in making retail sales:

  • the credit card issuer
  • the retailer
  • the customer
bank credit card
Bank Credit Card
  • Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer.
  • Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller\'s bank balance.
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