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Chapter 8. Accounting for Receivables. Chapter Objectives. 1. Accounts Receivables and Notes Receivables 2. Using Accounting for Decision Making. Accounts Receivable and Notes Receivable.

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chapter 8

Chapter 8

Accounting for Receivables

chapter objectives
Chapter Objectives
  • 1. Accounts Receivables and Notes Receivables
  • 2. Using Accounting for Decision Making

Short-Term Investments & Receivables

accounts receivable and notes receivable
Accounts Receivable and Notes Receivable
  • Receivables: monetary claims against business or individuals from selling goods, providing services or lending money (i.e., accounts receivable, notes receivable, interest receivable).

Short-Term Investments & Receivables

slide4
A. Accounts Receivable (A/R) (trade receivables): An oral promise for future cash receipt as a result of sales; a current asset.
  • The accounts receivable account in the general ledger serves as a control account which records the total amounts of receivable from all customers. Companies also keep subsidiary ledger accounts receivable for each customer.

Short-Term Investments & Receivables

a accounts receivable continued
A. Accounts Receivable (Continued)

General Ledger

A/R

Bal. 10,000

Subsidiary Ledger

A/R

A. Company

Bal. 3,000

B. Company

Bal. 4,000

C. Company

Bal. 3,000

Total $10,000

Journal Entries:

A/R - A Company 3000

Sales Revenue 3000

A/R - B Company 4000

Sales Revenue 4000

A/R - C Company 3000

Sales Revenue 3000

Short-Term Investments & Receivables

uncollectible accounts bad debts
Uncollectible Accounts (Bad Debts)
  • The benefit of allowing customers to purchase on credit (or on account) is the increase of sales.
  • The risk associates with this practice is the cost of uncollectible accounts.

Short-Term Investments & Receivables

the accounting for the uncollectible accounts bad debt b d expense
The Accounting for the Uncollectible Accounts (Bad Debt (B/D) Expense):
  • Current Practice: Estimate the B/D expense at the end of the period and recognize the expense (FASB No.5)
  • Adjusting entry for B/D expense:
  • Estimated B/D expense = $2,000
  • 12/31 B/D Exp. (or Uncollectible Accounts Expense) 2000
  • Allowance for Uncollectible Accounts 2000
  • Writing off uncollectible accounts:
  • When $200 B/D actually occurred:
  • Allowance for uncollectible Accounts 200
  • A/R - A Company 200

Short-Term Investments & Receivables

the accounting for the uncollectible accounts continued
The Accounting for the Uncollectible Accounts (Continued)
  • If $100 of the B/D recovered:
  • A/R 100
  • Allowance for Uncollectible Accounts 100
  • Cash 100
  • A/R 100
  • The current practice is complied with the matching principle.
  • The direct write-off method (recognize the B/D expense when it occurs) is NOT recommended.

Short-Term Investments & Receivables

estimation of b d expense
Estimation of B/D Expense:
  • 1. Percentage of net credit sales (I/S approach)
  • 2. Percentage of accounts receivable (B/S approach)
  • 3. Aging of accounts receivable (B/S approach using individual account information)

Short-Term Investments & Receivables

estimation of b d expense example
Estimation of B/D Expense Example:
  • 1. Net credit sales = $20,000
    • Estimated B/D expense = 2%
    • 12/31 B/D Expense 400
    • Allowance for uncollectible accounts 400

Short-Term Investments & Receivables

estimation of b d expense example continued
Estimation of B/D Expense Example: (Continued)
  • 2. Percentage of A/R:
    • A/R Balance = $50,000
    • Estimated B/D expense = 1%
    • Balance of the Allowance for uncollectible accounts prior to the adjustment= $300
    • The adjusted balance of the allowance for uncollectible accounts = $50,000 * 1% = $500
    • Bad Debt Expense = $500 - 300 = 200
    • B/D expense 200
    • Allowance for uncollectible accounts 200

Short-Term Investments & Receivables

estimation of b d expense example continued1
Estimation of B/D Expense Example: (Continued)
  • 3. Aging-of-A/R: The balance of the allowance account prior to adjustment= $100
    • B/D expense = $440 - 100 = 340
    • 12/31 adjusting entry:
    • B/D Expense 340
    • Allowance for uncollectible accounts 340

Short-Term Investments & Receivables

estimation of b d expense1
Estimation of B/D Expense
  • All three estimation methods are acceptable for the financial reports. In practice, some companies use the percentage of sales method for the interim statements (i.e., monthly or quarterly reports), but use the aging of accounts receivable method for the annual financial reports.

Short-Term Investments & Receivables

credit card sales
Credit-Card Sales
  • Benefits of credit-card sales to
  • a. Customers: the convenience of purchase and payment.
  • b. Companies (the sellers):
    • 1)no risk of uncollectible accounts;
    • 2)no need to do a credit check;

Short-Term Investments & Receivables

credit card sales continued
Credit-Card Sales (Continued)
    • 3) increase of sales;
    • 4) receive cash quickly.
  • c. Credit-Card Companies: charge 2% to 6% of service charge to the seller (source: Weygandt, etc. textbook).
  • Disadvantages of credit-card sales to customers, companies (the sellers) and the credit-card companies:

Short-Term Investments & Receivables

accounting for credit card sales credit cards issued by a financial company
Accounting for Credit Card Sales – Credit Cards Issued by a Financial Company:
  • Example: Suppose you shopped at the Gap and paid $100 for a sweater using a VISA card. Gap’s entry to record the VISA card sale, subject to 2% VISA discount (the service charge by VISA):
    • Cash 98
    • Service Charge Expense 2
    • Sales Revenue 100

Short-Term Investments & Receivables

b accounting for notes receivable
B. Accounting for Notes Receivable
  • For an example of a promissory note, see Illustration 8-10 of Weygandt, etc. textbook.
  • N/R: a written promissory note that the debtor (the maker of the note) promises to pay the creditor (the payee) the written amount on a specific date plus the agreeable interest.

Short-Term Investments & Receivables

b accounting for notes receivable continued
B. Accounting for Notes Receivable (Continued)
  • Short-Term N/R: the note is due within one year or one operating cycle, whichever is longer. Short-term N/R is recorded at the amount expected to be collected.
  • Long-Term N/R: the due date of the note is beyond one year or one operating cycle, whichever is longer.
  • For interest bearing N/R, the accrued interest is recognized at the end of period.

Short-Term Investments & Receivables

example a
Example (a):
  • a. Greenway Co. signed a promissory note to borrow $1,000 from Kay Bank on 9/30/08. The note is an interest bearing note with an annual interest rate of 12%. The maturity of the note is on 3/31/09 (i.e., a six-month note).

Kay Bank’s entries are as follows:

9/30/08 Note Receivable -- Greenway 1,000

Cash 1,000

Short-Term Investments & Receivables

example a continued
Example (a): (Continued)
  • 12/31/08 Interest Receivable 30
  • Interest Revenue 30
  • 3/31/09 Cash 1,060
  • Note Receivable -- Greenway 1,000
  • Interest Receivable 30
  • Interest Revenue 30

Short-Term Investments & Receivables

example b
Example (b):
  • b. On 4/16/08, Gateway Co. receives a $12,000 90-day promissory note at 12% annual interest from a customer (Four Seasons) from selling personal computers. Gateway’s entries to record the sale and collection are:

4/16/08 N/R -- Four Seasons 12,000

Sales Revenue 12,000

7/15/08 Cash 12,360

N/R 12,000

Interest Revenue 360

Interest = $12,000x12% x 90/360 = $360

dishonored note
Dishonored Note
  • If Four Season (the maker) failed to pay Gateway (the payee) on 7/15/08, Gateway will make the following entry:
  • Accounts Receivable 12,360
  • Note Receivable 12,000
  • Interest Revenue 360

Short-Term Investments & Receivables

example c
Example (c):
  • c. On 5/2/08, Grouti Co. sees that it will not be able to pay off its $5,000 account payable to GE Co. Grouti negotiated with GE. GE accepts a one-year $5,000 promissory note, with 10% interest from Grouti on 5/17/08 to settle Grouti’s $5,000 account receivable. GE’s entry is:

Note Receivable -- Grouti Co. 5,000

Accounts Receivable -- Grouti Co. 5,000

Short-Term Investments & Receivables

using receivables to finance operations
Using Receivables to Finance Operations
  • 1. Discounting Notes Receivables (with contingent liabilities).
  • 2. Factoring Accounts Receivables

Short-Term Investments & Receivables

internal control issue of receivables
Internal Control Issue of Receivables
  • Separation of bookkeeping of receivable accounts from receiving of cash payments

Short-Term Investments & Receivables

using accounting for decision making
Using Accounting for Decision Making
  • Current ratio = Current Assets
    • Current Liabilities

Short-Term Net Current

Acid-Test (Quick) ratio = Cash + Investment + Receivables

Current Liabilities

In general, a quick ratio of 1 is considered to be safe.

Short-Term Investments & Receivables

average collection period
Average Collection Period
  • Accounts receivable turnover rate =
  • Net credit sales (annual) /average net A/R
  • Average collection period =
  • 365 days / Accounts rece. turnover rate

Short-Term Investments & Receivables

average collection period contd
Average Collection Period (contd.)
  • Example:
  • Net Credit Sales (annual)= $912,500
  • Average A/R = $60,000
  • Accounts receivable turnover rate
  • =$912,000/$60,000 = 15.2 (times)
  • Average Collection Period of A/R
  • =365 days/15.2 = 24 days

Short-Term Investments & Receivables