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Receivables. Chapter 8. Receivables. Selling goods or services to another party on credit Right to receive cash in the future from a current transaction Two types: Accounts receivable Notes receivable An asset. Accounts Receivable.

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receivables

Receivables

Chapter 8

receivables1
Receivables
  • Selling goods or services to another party on credit
  • Right to receive cash in the future from a current transaction
  • Two types:
    • Accounts receivable
    • Notes receivable
  • An asset
accounts receivable
Accounts Receivable
  • Amounts to be collected from customers for sales on credit
  • Serves as a control account
    • Control account –account that summarizes related subsidiary accounts.
  • Customer ledger
    • Subsidiary ledger showing each customer’s balance
notes receivable
Notes Receivable
  • More formal than accounts receivable
  • Usually longer in term
    • Debtor promises to pay by maturity date
    • Maturity date–date the debt must be completely paid off
  • Current assets if due within one year or less
  • Long-term assets if due beyond one year
  • Promissory note
    • Written document signed by both parties
internal controls and receivables
Internal Controls and Receivables
  • Credit department evaluates customers’ applications
  • Separation of duties
    • Credit department should not handle cash
    • Cash handlers should not extend credit
s8 1 different types of receivables
S8-1: Different types of receivables

What is the difference between accounts receivable and notes receivable?

Notes receivable include a charge for interest; accounts receivable do not.

Accounts receivable are current assets; notes receivable are current or long-term assets.

Notes receivable are more formal than accounts receivable.

Notes receivable are evidenced by the debtor signing a promissory note; accounts receivable are not.

accounting for uncollectibles bad debts
Accounting for Uncollectibles (Bad Debts)
  • Selling on credit:
    • BENEFIT–Increase sales by selling to a wider range of customers
    • COST–Some customers don’t pay
      • Results in uncollectible account expense
  • Two methods to account for uncollectible accounts:
    • Allowance method
    • Direct write-off method
accounting for uncollectibles bad debts1
Accounting for Uncollectibles (Bad Debts)
  • Starts with selling on account
  • Collecting cash is the second step
allowance method
Allowance Method
  • Based on the matching principle
    • Record uncollectible accounts expense in same period as sales
    • Expense is estimated from past experience
  • Offset to expense is the allowance for uncollectible accounts
    • A contra asset, contra to accounts receivable
    • Reduces account receivables to a net receivable
estimating uncollectibles
Estimating Uncollectibles
  • Companies use their history, the economy and industry information to estimate uncollectibles
  • Percent-of-sales
    • Income-statement approach
    • Estimates uncollectible accounts as a percent of sales
  • Aging-of-accounts
    • Balance-sheet approach
    • Determine target allowance based on age of actual receivables
percent of sales method
Percent-of-Sales Method
  • Begins with account balances
    • Beginning balance below
  • Compute the estimate and journalize it
  • Net realizable value is the expected amount to collect
s8 3 applying the allowance method percent of sales to account for uncollectibles
S8-3 : Applying the allowance method (percent-of-sales) to account for uncollectibles

During its first year of operations, Spring Garden Plans earned revenue of $322,000 on account. Industry experience suggests that bad debts will amount to 2% of revenues.

At December 31, 2012, accounts receivable total $36,000. The company uses the allowance method to account for uncollectibles.

s8 3 applying the allowance method percent of sales to account for uncollectibles1
S8-3: Applying the allowance method (percent-of-sales) to account for uncollectibles
  • Journalize Spring’s sales and uncollectible account expense using the percent-of sales method.
s8 3 applying the allowance method percent of sales to account for uncollectibles2
S8-3: Applying the allowance method (percent-of- sales) to account for uncollectibles

2. Show how to report accounts receivable on the balance sheet at December 31, 2012. Use the long reporting format illustrated in the chapter.

aging method
Aging Method
  • Focuses on actual age of the accounts receivable
  • Determines a target allowance balance

AR

Total

Expected not to collect

aging method1
Aging Method
  • The amount not expected to be collected becomes the allowance account target balance
aging method2
Aging Method
  • Journal entry
    • $150 credit balance plus/minus adjustment = $400

250

$400

s8 5 applying the allowance method aging of accounts to account for uncollectibles
S8-5: Applying the allowance method (aging-of-accounts) to account for uncollectibles

Summer and Sandcastles Resort had the following balances at December 31, 2012, before the year-end adjustments:

The aging of accounts receivable yields the following data:

Accounts receivable Allowance for uncollectible accounts

78,000 Beg Bal 1,900

s8 5 applying the allowance method aging of accounts to account for uncollectibles1
S8-5 : Applying the allowance method (aging-of-accounts) to account for uncollectibles
  • Journalize Summer’s entry to adjust the allowance account to its correct balance at December 31, 2012.
  • Prepare a T-account to compute the ending balance of Allowance for uncollectible accounts.

Accounts receivable Allowance for uncollectible accounts

78,000 Beg Bal 1,900

Adj 1,820

_ __________________________________________

End Bal 3,720

writing off uncollectible accounts
Writing off Uncollectible Accounts
  • When a specific customer account is identified as uncollectible, it is written off to the allowance account
recovery of account
Recovery of Account
  • Sometimes a customer will pay the amount owed after the customer’s account is written off
  • Two entries needed:
    • Reverse the uncollectable account
    • Record the payment
summary of entries
Summary of Entries
  • Make sales on account
  • Establish a pool for future potential uncollectibility(?%)
  • Collect cash on account
  • Identify a bad debt
  • Adjust allowance account to reflect adjustments to the estimate
  • Recover previously written off account
direct write off method
Direct Write-Off Method
  • Used by small businesses
  • No Allowance for uncollectible accounts
  • Records uncollectible accounts expense when specific account is written off
problems with direct write off method
Problems with Direct Write-Off Method
  • Overstates Accounts receivable on the balance sheet
    • No Allowance account
  • Violates matching principle
    • Uncollectible account expense often not in same period as sale
  • Not GAAP
direct write off recovery of debt
Direct Write-off Recovery of Debt
  • Direct write-off of debt recovery process is different from the allowance method
  • The debt was written off the books
  • To recover:
    • Reverse the write-off journal entry
    • Record the cash payment
credit card sales
Credit Card Sales
  • Credit-card sales are an alternative form for receiving payments
  • Two types:
    • Issued by a financial institution
      • Visa
      • Mastercard
    • Issued by a credit card company
      • American Express
      • Discover
debit cards
Debit Cards
  • Different than credit and bankcards
  • Same as cash
    • Amount subtracted from buyer’s bank account
    • Amount added to retailer’s bank account
bank cards
Bank Cards
  • Retailers receive cash at time of sale
  • Visa and MasterCard most common bank cards
  • Retailer accepting the credit cards pays a fee
  • Two types of fee transactions:
    • NET: The total sale less the processing fee assessed equals the net amount of cash deposited
    • Gross: The total sale is deposited and the fee is deducted at the end of the month
      • Journal entry similar to cash sales
s8 8 recording credit card and debit card sales
S8-8 : Recording credit-card and debit-card sales

Restaurants do a large volume of business by credit and debit cards. Suppose Chocolate Passion restaurant had these transactions on January 28, 2012:

National Express credit-card sales . . . . . $ 9,300

ValueCard debit-card sales . . . . . . . . . . . 9,000

Suppose Chocolate Passion’s processor charges a 3% fee and deposits sales net of the fee.

Requirement:

1. Journalize these sale transactions for the restaurant.

s8 8 recording credit card and debit card sales1
S8-8 : Recording credit-card and debit-card sales

National Express credit-card sales . . . . . $ 9,300

ValueCard debit-card sales . . . . . . . . . . . 9,000

notes r eceivable
Notes Receivable
  • More formal than Accounts receivable
  • Debtor signs promissory note
    • A written promise to pay a specified amount of money at a particular future date
identifying maturity date
Identifying Maturity Date
  • Maturity date can be:
    • A specific date, such as March 13
    • Stated in terms of number of months
      • A six-month note dated February 16, 2014, would mature on August 16, 2014
    • Stated in terms of number of days
      • Must count days from issue date to maturity day
computing interest
Computing Interest
  • By the year
  • By the month
  • By the day

360 days used in this example to simplify calculations

accruing interest revenue
Accruing Interest Revenue
  • If notes receivable are outstanding, interest must be accrued
  • Interest is earned over time
  • Revenue must be recorded in the period earned
accruing interest timeline
Accruing Interest Timeline
  • On the maturity date
converting accounts receivable to notes receivable
Converting Accounts Receivable toNotes Receivable
  • A company may accept a note receivable from a customer who fails to pay an account receivable
s8 10 accounting for a note receivable
S8-10 : Accounting for a note receivable

Lakeland Bank & Trust Company lent $110,000 to Samantha Michael on a 90-day, 9% note.1. Journalize the following transactions for the bank (explanations are not required):

  • Lending the money on June 6.
  • Collecting the principal and interest at maturity. Specify the date. For the computation of interest, use a 360-day year.
s8 10 accounting for a note receivable1
S8-10 : Accounting for a note receivable

Lending the money on June 6.

Collecting the principal and interest at maturity. Specify the date.

For the computation of interest, use a 360-day year.

dishonored notes receivable
Dishonored Notes Receivable
  • Maker of note does not pay
  • Move the note receivable into accounts receivable
  • Interest is added to the new accounts receivable
accounts receivable on the balance sheet
Accounts Receivable on the Balance Sheet
  • Current asset, shown net of allowances
  • Two presentation styles:
acid test ratio
Acid-Test Ratio
  • Also called the “quick ratio”
  • Stringent measure of liquidity
  • Measures entity’s ability to pay its current liabilities immediately
accounts receivable turnover ratio
Accounts Receivable Turnover Ratio
  • Measures the number of times the company sells and collects the average receivables
  • Higher the ratio, the faster the cash collections occur
  • Benchmark on how well a company is managing its receivables
days sales in receivables
Days’ Sales in Receivables
  • Also called “collection period”
  • It is number of days it takes to collect the average balance of receivables
  • The shorter the collection period, the more quickly cash is available
  • Two step process:
    • Find one day’s sales
    • Find day’s sales in receivables
days sales in receivables1
Days’ Sales in Receivables
  • Step 1: One day’s sales is calculated
    • Net sales (Total revenues) divided by 365 days per year
days sales in receivables2
Days’ Sales in Receivables
  • Step 2: Day’s sales in inventory
    • Average net receivables divided by one days sales
days sales in receivables3
Days’ Sales in Receivables
  • Alternative Calculation
    • 365 days divided by Accounts Receivable Turnover Ratios
    • 365/9.04 = 40 days (rounded)
s8 11 reporting receivables and other accounts in the financial statements
S8-11 : Reporting receivables and other accounts in the financial statements

2. Show two ways Northend can report receivables on its classified balance sheet:

s8 12 using the acid test ratio and days sales in receivables to evaluate a company
S8-12 : Using the acid-test ratio and days’ sales in receivables to evaluate a company

Southside Clothiers reported the following items at September 30, 2012 (last year’s—2011—amounts also given as needed):

Compute Southside’s (a) acid-test ratio, (b) days’ sales in average receivables for 2012, and (c) accounts receivable turnover ratio. Evaluate each ratio value as strong or weak. Southside sells on terms of net 30.

s8 12 using the acid test ratio and days sales in receivables to evaluate a company1
S8-12 : Using the acid-test ratio and days’ sales in receivables to evaluate a company
  • Acid-test ratio =
        • Cash + Short-term investments + Net current receivables Total current liabilities

= $260,000 + $140,000 + $270,000

  $500,000

 = $670,000$500,000

 = 1.34

Southside’s position is strong.

s8 12 using the acid test ratio and days sales in receivables to evaluate a company2
S8-12 : Using the acid-test ratio and days’ sales in receivables to evaluate a company

(b) Days’ sales in average receivables =

* Average net accounts receivable

** One day’s sales

*Average net accounts receivable = $170,000+270,000/2

= *$220,000

**One day’s sale=(Net sales/365 days) = $2,920,000/365 days

= **$8,000

The days’ sales in average receivables are strong relative to credit terms of net 30.

Alternative Calculation: 365 days/13.3 = 27.4

*$220,000 **$8,000

= 27.5 days

s8 12 using the acid test ratio and days sales in receivables to evaluate a company3
S8-12 : Using the acid-test ratio and days’ sales in receivables to evaluate a company

Southside’s accounts receivable turnover ratio is strong relative to credit terms of net 30.

Alternative Calculation: 365 days/13.3 = 27.4