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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

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 or services.

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 or services.

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 or services.

Describe the tradeoffs of extending credit.


Pros and cons of extending credit

Extending credit is likely to increase or services.sales, 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 or services.

Estimate and report the effects of uncollectible accounts.


Accounts receivable and bad debts
Accounts Receivable or services.and 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 Receivable or services.and 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 or services.

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 or services.

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


Record estimated bad debt expense
Record Estimated or services.Bad 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 or services.

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 business or services.expects to collect.

Allowance for Doubtful Accounts

Balance Sheet Disclosure


Remove write off specific customer balances

When it is clear that a or services.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 for or services.2005 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 or services.

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 or services.

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 or services.

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 or services.

????

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 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.

(in thousands)

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


Aging schedule2
Aging Schedule 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.

(in thousands)

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


Aging schedule3
Aging Schedule 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.

(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 Allowance for Doubtful Accounts currently has a $4,314,000 credit balance.

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


Aging of accounts receivable2
Aging of Accounts Receivable Allowance for Doubtful Accounts currently has a $4,314,000 credit balance.

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 Allowance for Doubtful Accounts currently has a $4,314,000 credit balance.– 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 Allowance for Doubtful Accounts currently has a $4,314,000 credit balance.

Compute and report interest on notes receivable.


Notes receivable and interest revenue
Notes Receivable and Allowance for Doubtful Accounts currently has a $4,314,000 credit balance.Interest 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 on annualized.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.

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 annualized.

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 annualized.

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 annualized.

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 Received annualized.and 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 annualized.

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 annualized.

Compute and interpret the receivables turnover ratio.


Receivables turnover analysis

Receivables Turnover annualized.Ratio

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 Turnover annualized.Ratio

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 annualized.

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 annualized.

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 annualized.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 8 annualized.Supplement

Percentage of Credit Sales Method


Percentage of credit sales
Percentage of Credit Sales annualized.

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 sales2
Percentage of Credit Sales annualized.

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.



Direct write off method
Direct Write-Off Method annualized.

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 annualized.