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Chapter 8

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

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  1. Chapter 8 Accounting for Receivables

  2. Chapter Objectives • 1. Accounts Receivables and Notes Receivables • 2. Using Accounting for Decision Making Short-Term Investments & Receivables

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. 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

  18. 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

  19. 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

  20. 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

  21. 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

  22. 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

  23. 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

  24. Using Receivables to Finance Operations • 1. Discounting Notes Receivables (with contingent liabilities). • 2. Factoring Accounts Receivables Short-Term Investments & Receivables

  25. Internal Control Issue of Receivables • Separation of bookkeeping of receivable accounts from receiving of cash payments Short-Term Investments & Receivables

  26. 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

  27. 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

  28. 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

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