Financial Accounting: Tools for Business Decision Making, 2nd Ed.

1. Financial Accounting:Tools for Business Decision Making, 2nd Ed. ELS Kimmel, Weygandt, Kieso Prepared by: Ellen L. Sweatt Georgia Perimeter College

2. Chapter 8 Reporting and Analyzing Receivables

3. 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 maturity date of and interest on notes receivable. • Describe the entries to record the disposition of notes receivable.

4. 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.

5. Receivables... • Amounts due from individuals and companies- expected to be collected in cash. • Frequently classified as: • Accounts receivable • Notes receivable • Other receivables

6. 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.

7. Illustration 8-9 Notes Receivable... Represent claims for which formal instruments of credit are issued as evidence of debt. 2001

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

9. Accounts Receivable... Are recorded when service is provided or at point of sale of merchandise on account. Accounts Receivable 100 Sales 100

10. Bad Debts Expense... Is an expense to record estimated uncollectible receivables. Keeps Expenses from Being Understated on the Income Statement.

11. 2 Methods for Accounting for Uncollectible Accounts • The Direct Write-off Method • The Allowance Method

12. 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

13. 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

14. 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

15. 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

16. 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.

17. HAMPTON FURNITURE Balance Sheet (partial) Illustration 8-4 Cash (net) Realizable Value Current assets Cash $ 14,800 Accounts receivable $200,000 Less: Allowance for doubtful accounts 12,000 188,000

18. HAMPTON FURNITURE Balance Sheet (partial) Illustration 8-4 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

19. 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

20. Illustration 8-5 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

21. Before Write-off Illustration 8-6 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

22. Recovery of an Uncollectible Account Accounts Receivable-Ware 500 Allowance for Doubtful Accounts 500 Cash 500 Accounts Receivable 500

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

24. 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.

25. Trade Receivables... Notes and accounts receivables that result from sales transactions.

26. Notes Receivable... • Result from sale of goods and services. • Often called trade receivable. • Give holder a stronger legal claim to assets than accounts receivable. • Are negotiable instruments and may be transferred to another party by endorsement.

27. Notes Receivable... Credit instrument normally requires: • payment of interest • extends for time periods of 60-90 days or longer.

28. Are often accepted from customers who need to extend payment of an account receivable. Are often required from high-risk customers. Notes Receivable...

29. Notes Receivable • The life of a note may be expressed in months or days. • When the life of a note is expressed in terms of months, the due date is found by counting the months from the date of issue.

30. Notes Receivable • When the due date is stated in terms of days, count the exact number of days to determine the maturity date. • In counting, the date the note is issued is omitted but the due date is included.

31. Illustration 8-9 Notes Receivable... Represent claims for which formal instruments of credit are issued as evidence of debt. 2001

32. Term of note 60 days July (31-17) 14 August 31 45 Maturity date, September 15 Illustration 8-10 Maturity Date The maturity date of a 60-day note dated July 17 is computed as follows:

33. 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.

34. Illustration 8-11 Formula for Interest

35. 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.

36. Notes Receivable... • Interest revenue is recorded when the note is paid. • If interim financial statements are prepared, interest on notes receivable is accrued.

37. 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.

38. 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.

39. Managing Receivables • Determine to whom to extend credit. • Establish a payment period. • Monitor collections. • Evaluate receivables balance. • Accelerate cash receipts from receivables when necessary.

40. 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.

41. 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.

42. 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.

43. Illustration 8-14 Credit Risk Ratio... Is a measure of the risk that a company’s customers may not pay their accounts. Credit Risk Ratio= Allowance for Doubtful Accounts Accounts Receivables Changes in credit risk ratio over time suggests that a company’s overall credit risk is increasing and decreasing.

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

45. 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.

46. Illustration 8-17 Receivables Turnover Ratio= Net Credit Sales Average Net Receivables Is a measure of the liquidity of receivables.

47. Illustration 8-17 Average Collection Period= 365 days Receivables Turnover Ratio Is the average amount of time that a receivable is outstanding

48. Accelerating Cash Receipts Waiting for the normal collection process cost money.

49. Accelerating Cash Receipts A bird in the hand is worth two in the bush.

50. 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.