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Financial Accounting: Tools for Business Decision Making, 3rd Ed.

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  1. Financial Accounting:Tools for Business Decision Making, 3rd Ed. ELS Kimmel, Weygandt, Kieso

  2. Chapter 8

  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 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. Receivables Differ Depending On... • Industry • Time of year • Whether the company extends long-term financing • Credit policies

  7. 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.

  8. Problems with Accounts Receivable • Recognizing accounts receivable. • Valuing accounts receivable.

  9. Accounts Receivables... • Are reduced as a result of: • Sales discounts • Sales returns and allowances

  10. Notes Receivable... Represent claims for which formal instruments of credit are issued as evidence of debt. 2004

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

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

  13. 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.

  14. 2 Methods for Accounting for Uncollectible Accounts • The Direct Write-off Method • The Allowance Method

  15. 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

  16. Direct Write-off Method Issue No attempt is made to match bad debts expense to sales revenue.

  17. 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

  18. 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

  19. 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

  20. 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.

  21. 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

  22. 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

  23. 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

  24. 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

  25. 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

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

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

  28. 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.

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

  30. Notes Receivable... • Credit which is extended by use of a formal instrument.

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

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

  33. Notes Receivable... Represent claims for which formal instruments of credit are issued as evidence of debt. 2004

  34. 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.

  35. Formula for Interest

  36. 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.

  37. 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

  38. 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.

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

  40. 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.

  41. 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.

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

  43. 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.

  44. 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.

  45. 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.

  46. 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.

  47. 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.

  48. Receivables Turnover Ratio= Net Credit Sales Average Net Receivables Is a measure of the liquidity of receivables.

  49. Average Collection Period= 365 days Receivables Turnover Ratio Is the average amount of time that a receivable is outstanding

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