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Chapter 8 Chapter 8 Reporting 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.

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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.


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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.


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Receivables...

  • Amounts due from individuals and companies - expected to be collected in cash.

  • Frequently classified as:

    • Accounts receivable

    • Notes receivable

    • Other receivables


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Receivables Differ Depending On...

  • Industry

  • Time of year

  • Whether the company extends long-term financing

  • Credit policies


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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.


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Accounts Receivable...

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

Accounts Receivable 100

Sales 100


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Problems with Accounts Receivable

  • Recognizing accounts receivable.

  • Valuing accounts receivable.


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Accounts Receivables...

  • Are reduced as a result of:

    • Cash rceipts

    • Sales discounts

    • Sales returns and allowances


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Other Receivables

Notes receivable from customers

Nontrade receivables including:

  • interest receivable

  • loans to company officers

  • advances to employees

  • income taxes refundable


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Bad Debts Expense...

Is an expense to record estimated uncollectible receivables.

Keeps expenses from being understated

on the income statement and accounts

receivable from being overstated on the

balance sheet.


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2 Methods for Accounting for Uncollectible Accounts

  • The Direct Write-off Method (Not GAAP)

  • The Allowance Method


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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


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Direct Write-off Method Issue

No attempt is made to match bad debts expense to sales revenue; therefore, this method is not acceptable under GAAP.


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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


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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


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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


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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.


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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


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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


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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


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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


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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


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Recovery of an Uncollectible Account

Accounts Receivable-Ware 500 Allowance for Doubtful

Accounts 500

Cash 500

Accounts Receivable 500

OR

Cash 500

Allowance for Doubtful

Accounts 500


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Percentage of Receivables...

Management establishes a percentage relationship between the amount of receivables and the expected losses from uncollectible accounts based on historical loss experience


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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.


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Notes Receivable...

Credit instrument normally requires:

  • payment of interest

  • extends for time periods of 60-90 days or longer.


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Are often accepted from customers who need to extend payment of an account receivable.

Are often required from high-risk customers.

Notes Receivable...


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Notes Receivable... of an account receivable.

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

2004


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Maker of an account receivable.

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.


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Formula for Interest of an account receivable.


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1,000 x .12 x 12 months/12months of an account receivable.

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.


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Interest rate specified on a note is an of an account receivable.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


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Notes Receivable... of an account 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.


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Notes Receivable... of an account receivable.

  • Interest revenue is recorded when the note is paid.

  • If interim financial statements are prepared, interest on notes receivable is accrued.


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Notes Receivable... of an account 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.


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Notes Receivable... of an account 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.


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Managing Receivables of an account receivable.

  • Determine to whom to extend credit.

  • Establish a payment period.

  • Monitor collections.

  • Evaluate receivables balance.

  • Accelerate cash receipts from receivables when necessary.


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Extending Credit of an account receivable.

  • 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.


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Payment Period of an account receivable.

  • Determine a required payment period and communicate that policy to customers.

  • Make sure company's payment period is consistent with that of competitors.


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Monitoring Collections of an account receivable.

  • 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.


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Concentration of Credit Risk of an account receivable.

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


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Evaluating the of an account receivable.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.


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Receivables Turnover Ratio= of an account receivable.

Net Credit Sales

Average Net Receivables

Is a measure of the liquidity

of receivables.


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Average Collection Period= of an account receivable.

365 days

Receivables Turnover Ratio

Is the average amount of time that a receivable is outstanding


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Accelerating Cash Receipts of an account receivable.

Waiting for the normal collection process costs money.


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Companies Sell Receivables of an account receivable.

  • 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.


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Factor... of an account receivable.

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


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Expense Associated with Selling Receivables of an account receivable.

  • 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.


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Credit Card of an account receivable.

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

  • the credit card issuer

  • the retailer

  • the customer


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Bank Credit Card of an account receivable.

  • 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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Advantages of Credit Cards to the Retailer of an account receivable.

  • Issuer does credit investigation of customer

  • Issuer maintains customer accounts

  • Issuer takes collection action and absorbs credit losses

  • Retailer receives cash sooner