8 1 8 Reporting and Analyzing Receivables Kimmel

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8 Reporting and Analyzing Receivables Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition 8 -2

CHAPTER OUTLINE LEARNING OBJECTIVES 8 -3 1 Explain how companies recognize accounts receivable. 2 Describe how companies value accounts receivable and record their disposition. 3 Explain how companies recognize, value, and dispose of notes receivable. 4 Describe the statement presentation of receivables and the principles of receivables management.

Who will pay us back? Explain. l l l 8 -4 Customer of 20 years. Known community member. Generally pays on time. When past due in the past, always “makes good”. Has been late with payments 4 x in the last year. Is currently 90 days “past due”. l l l Customer of less than 1 year. Known community member. No significant payment history (it’s only been one year). Has been 2 x late in the last year. Is currently 45 days “past due”.

? ? ? ? ? ? ? ? ? 8 -5 LO 1 Identify the different types of receivables.

LEARNING OBJECTIVE 1 Explain how companies recognize accounts receivable. Amounts due from individuals and companies that are expected to be collected in cash. Amounts customers owe on account that result from the sale of goods and services. Written promise (formal instrument) for amount to be received. Also called trade receivables. Accounts Receivable Notes Receivable 8 -6 Nontrade receivables such as interest, loans to officers, advances to employees, and income taxes refundable. Other Receivables LO 1

Accounts Receivable Three accounting issues: 1. Recognizing accounts receivable. 2. Valuing accounts receivable. 3. Disposing of accounts receivable. Recognizing Accounts Receivable The following exercise was illustrated in Chapter 5. For simplicity, inventory and cost of goods sold have been omitted. 8 -7 LO 1 Identify the different types of receivables.

TYPES OF RECEIVABLES Amounts due from individuals and companies that are expected to be collected in cash. ILLUSTRATION 8 -1 Receivables as a percentage of assets 8 -8 LO 1

RECOGNIZING ACCOUNTS RECEIVABLE Service organization records a receivable when it performs service on account. u Merchandiser records accounts receivable at the point of sale of merchandise on account. u Seller may offer a discount to encourage early payment. u Buyer might return goods found to be unacceptable. Fr om th ep re vio u sc ha pt er s u 8 -9 ► Sales returns reduce receivables. LO 1

RECOGNIZING ACCOUNTS RECEIVABLE Illustration: Assume that Jordache Co. on July 1, 2017, sells merchandise on account to Polo Company for $1, 000 terms 2/10, n/30. Prepare the journal entry to record this transaction on the books of Jordache Co. Jul. 1 Accounts Receivable 1, 000 Sales Revenue 8 -10 1, 000 LO 1

RECOGNIZING ACCOUNTS RECEIVABLE Illustration: On July 5, Polo returns merchandise worth $100 to Jordache Co. Jul. 5 Sales Returns and Allowances Accounts Receivable 100 Illustration: On July 11, Jordache receives payment from Polo Company for the balance due. Jul. 11 8 -11 Cash ($900 - $18) 882 Sales Discounts ($900 x. 02) 18 Accounts Receivable 900 LO 1

RECOGNIZING ACCOUNTS RECEIVABLE Illustration: Some retailers issue their own credit cards. Assume that you use your JCPenney Company credit card to purchase clothing with a sales price of $300. Accounts Receivable 300 Sales Revenue 300 Assuming that you owe $300 at the end of the month, and JCPenney charges 1. 5% per month on the balance due Accounts Receivable 4. 50 Interest Revenue 8 -12 4. 50 LO 1

RECOGNIZING ACCOUNTS RECEIVABLE E 5 -5 Prepare the journal entries for Wheeler Company. 1. On December 3, Wheeler Company sold $500, 000 of merchandise to Hashmi Co. , terms 2/10, n/30, FOB shipping point. Dec. 3 8 -13 Accounts receivable 500, 000 Sales 500, 000 LO 2 Explain how companies recognize accounts receivable.

RECOGNIZING ACCOUNTS RECEIVABLE E 5 -5 Prepare the journal entries for Wheeler Company. 2. On December 8, Hashmi Co. was granted an allowance of $100, 000 for merchandise purchased on December 3. Dec. 8 8 -14 Sales returns and allowances Accounts receivable 100, 000 LO 2 Explain how companies recognize accounts receivable.

RECOGNIZING ACCOUNTS RECEIVABLE E 5 -5 Prepare the journal entries for Wheeler Company. 3. On December 13, Wheeler Company received the balance due from Hashmi Co. Dec. 13 Cash 392, 000 *** Sales discounts 8, 000 Accounts receivable ** * ($500, 000 – $27, 000) ** [($500, 000 – $27, 000) X 2%] 400, 000 * *** ($473, 000 – $9, 460) 8 -15 LO 2 Explain how companies recognize accounts receivable.

ANATOMY OF A FRAUD Tasanee was the accounts receivable clerk for a large non-profit foundation that provided performance and exhibition space for the performing and visual arts. Her responsibilities included activities normally assigned to an accounts receivable clerk, such as recording revenues from various sources that included donations, facility rental fees, ticket revenue, and bar receipts. However, she was also responsible for handling all cash and checks from the time they were received until the time she deposited them, as well as preparing the bank reconciliation. Tasanee took advantage of her situation by falsifying bank deposits and bank reconciliations so that she could steal cash from the bar receipts. Since nobody else logged the donations or matched the donation receipts to pledges prior to Tasanee receiving them, she was able to offset the cash that was stolen against donations that she received but didn’t record. Her crime was made easier by the fact that her boss, the company’s controller, only did a very superficial review of the bank reconciliation and thus didn’t notice that some numbers had been cut out from other documents and taped onto the bank reconciliation. Total take: $1. 5 million The Missing Control Segregation of duties. The foundation should not have allowed an accounts receivable clerk, whose job was to record receivables, to also handle cash, record cash, make deposits, and especially prepare the bank reconciliation. Independent internal verification. The controller was supposed to perform a thorough review of the bank reconciliation. Because he did not, he was terminated from his position. 8 -16 LO 1

DO IT! 1 Recognizing Accounts Receivable More practice! On May 1, Wilton sold merchandise on account to Bates for $50, 000 terms 3/15, net 45. On May 4, Bates returns merchandise with a sales price of $2, 000. On May 16, Wilton receives payment from Bates for the balance due. Prepare journal entries to record the May transactions on Wilton’s books. (Ignore cost of goods sold entries. ) May Accounts Receivable—Bates 50, 000 Sales Revenue 50, 000 1 4 16 8 -17 Sales Returns and Allowances Accounts Receivable—Bates 2, 000 Cash ($48, 000 - $1, 440) Sales Discounts ($48, 000 x. 03) Accounts Receivable—Bates 46, 560 1, 440 2, 000 48, 000 LO 1

LEARNING OBJECTIVE 2 Describe how companies value accounts receivable and record their disposition. VALUING ACCOUNTS RECEIVABLE 8 -18 LO 2

LEARNING OBJECTIVE 2 Describe how companies value accounts receivable and record their disposition. VALUING ACCOUNTS RECEIVABLE u Valuation (net realizable value). It is the amount the company thinks they will be able to receive/collect later. u Valuation can be difficult because an unknown amount of receivables will become uncollectible. Uncollectible Accounts Receivable u Sales on account raise the possibility of accounts not being collected. 8 -19 u Seller records losses that result from extending LO 2

Aging of Accounts Receivable What does the spreadsheet below tell us? What does the spreadsheet NOT tell us? It will not tell us who will pay/not pay. 8 -20

VALUING ACCOUNTS RECEIVABLE 8 -21

VALUING ACCOUNTS RECEIVABLE Methods of Accounting for Uncollectible Accounts Direct Write-Off Theoretically undesirable: Allowance Method Losses are estimated: u No matching. u Better matching. u Receivable not stated at net realizable value. u Receivable stated at net realizable value. u Not acceptable for financial reporting. RISE! u Required by GAAP. SURP 8 -22 LO 2

Investors do not like surprises! 8 -23

It is like sharing bad grades with your parents! 8 -24

VALUING ACCOUNTS RECEIVABLE Allowance Method for Uncollectible Accounts 1. Companies estimate uncollectible accounts receivable. 2. To record estimated uncollectibles, companies debit Bad Debts Expense and credit Allowance for Doubtful Accounts (a contra-asset account). BDExp ADA 3. When companies write off specific uncollectible accounts, they debit Allowance for Doubtful Accounts and credit Accounts Receivable. ADA 8 -25 A/R LO 3 Distinguish between the methods and bases companies use to value accounts receivable.

VALUING ACCOUNTS RECEIVABLE Presented are transactions related to Wheeler Company. 1. On December 3 rd, Wheeler Company sold $500, 000 of merchandise to Hashmi Co. , terms 2/10, n/30, FOB shipping point. 2. On December 8 th, Hashmi Co. was granted an allowance of $100, 000 for merchandise purchased on December 3. New: #3: On December 26, Wheeler estimates that Hashmi will not be able to pay $200, 000 of their payable. #4: On Dec 27 th, Wheeler writes off the $200, 000 as uncollectible. Instructions: Prepare the journal entry for #3 & 4. 8 -26 LO 2 Explain how companies recognize accounts receivable.

VALUING ACCOUNTS RECEIVABLE (Wheeler Example) Allowance Method for Uncollectible Accounts 1. Companies estimate uncollectible accounts receivable. 2. To record estimated uncollectibles, companies debit Bad Debts Expense and credit Allowance for Doubtful Accounts (a contraasset account). Bad. Debt. Exp Allow. Dbt. Accts 200, 000 3. When companies write off specific uncollectible accounts, they debit Allowance for Doubtful Accounts and credit Accounts Receivable. Allow. Dbt. Accts. Rec 200, 000 8 -27 200, 000

PRESENTING ACCOUNTS RECEIVABLE Assets Current Assets: Cash Accounts receivable Less: Allowance for doubtful accts Merchandise inventory Prepaid expenses Total current assets $ 346, 000 $473, 000 (200, 000) 273, 000 150, 000 14, 000 $252, 000 cont 8 -28 ra a sset LO 3 Distinguish between the methods and bases companies use to value accounts receivable.

Direct Write-Off Method for Uncollectible Accounts Illustration: Assume that Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. Warden’s entry is: Bad Debt Expense 200 Accounts Receivable—M. E. Doran 200 Theoretically undesirable: u No matching. u Receivable not stated at cash realizable value. u 8 -29 Not acceptable for financial reporting. LO 2

Allowance Method for Uncollectible Accounts 1. Companies estimate uncollectible accounts receivable. 2. Debit Bad Debt Expense and credit Allowance for Doubtful Accounts (a contra-asset account). 3. Companies debit Allowance for Doubtful Accounts and credit Accounts Receivable at the time the specific account is written off as uncollectible. 8 -30 LO 2

You do!: Allowance Method for Uncollectibles RECORDING ESTIMATED UNCOLLECTIBLES Illustration: Hampson Furniture has credit sales of $1, 200, 000 in 2017, of which $200, 000 remains uncollected at December 31. The credit manager estimates that $12, 000 of these sales will prove uncollectible. Dec. 31 Bad Debt Expense 12, 000 Allowance for Doubtful Accounts Ask yo 8 -31 ect all of ll o c l il w I t b u o d do I use if I s t n u o c c a t a h W : urself 12, 000 my money? LO 2

Allowance Method for Uncollectibles – Financial Reporting Illustration 8 -3 Presentation of allowance for doubtful accounts 8 -32 LO 2

Allowance Method for Uncollectibles If we write off an account as uncollectible… can the person/company ever pay us? Yes! 8 -33 LO 2

Allowance Method for Uncollectibles WRITE-OFF OF AN UNCOLLECTIBLE ACCOUNT Illustration: The vice-president of finance of Hampson Furniture on March 1, 2018, authorizes a write-off of the $500 balance owed by Chester Mc. Nobbin. The entry to record the write-off is: Mar. 1 Allowance for Doubtful Accounts 500 Accounts Receivable— Chester Mc. Nobbin 500 counts do I use? l of my money what ac al e iv ce re t no ill w I I know Ask yourself: Now that ss (ADA) lo d e t a im t s e e s rid of th as an asset) it e e s r e This entry get g n lo he A/R (we no t f o id r s t e g And also 8 -34 ILLUSTRATION 8 -4 General ledger balances after writeoff LO 2

Allowance Method for Uncollectibles RECOVERY OF AN UNCOLLECTIBLE ACCOUNT Illustration: On July 1, Chester Mc. Nobbin pays the $500 amount that Hampson Furniture had written off on March 1. Bring back to life Hampson makes these entries: Hi! July 1 Get ! paid Accounts Receivable— Chester Mc. Nobbin Allowance for Doubtful Accounts 1 Cash 500 500 Accounts Receivable— Chester Mc. Nobbin 500 ▼ HELPFUL HINT Like the write-off, a recovery does not involve the income statement. 8 -35 LO 2

Allowance Method for Uncollectibles ESTIMATING THE ALLOWANCE ILLUSTRATION 8 -6 Nike’s allowance method disclosure 8 -36 LO 2

ESTIMATING THE ALLOWANCE Under the percentageof-receivables basis, management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts. Amount of bad debt expense that should be recorded in the adjusting entry is the difference between the required balance and the existing balance in the allowance account. 8 -37 LO 2

ESTIMATING THE ALLOWANCE Aging of Accounts Receivable 8 -38 Illustration 87 Aging ▼ HELPFUL HINT The percentage-ofreceivables basis may use only a single percentage rate. LO 2

ESTIMATING THE ALLOWANCE Illustration: Assume the unadjusted trial balance shows Allowance for Doubtful Accounts with a credit balance of $528. Prepare the adjusting entry assuming $2, 228 is the estimate of uncollectible receivables from the aging schedule. Dec. Bad Debt Expense 1, 700 31 Allowance for Doubtful Accounts 1, 700 8 -39 Illustration 8 -8 Bad debts accounts after posting LO 2

ACCOUNTS RECEIVABLE Illustration 8 -9 Sketchers USA’s note disclosure of accounts receivable 8 -40 LO 2

ETHICS INSIGHT Cookie Jar Allowances There are many pressures on companies to achieve earnings targets. For managers, poor earnings can lead to dismissal or lack of promotion. It is not surprising then that management may be tempted to look for ways to boost their earnings number. One way a company can achieve greater earnings is to lower its estimate of what is needed in its Allowance for Doubtful Accounts (sometimes referred to as “tapping the cookie jar”). For example, suppose a company has an Allowance for Doubtful Accounts of $10 million and decides to reduce this balance to $9 million. As a result of this change, Bad Debt Expense decreases by $1 million and earnings increase by $1 million. Large banks such as JP Morgan Chase, Wells Fargo, and Bank of America recently decreased their Allowance for Doubtful Accounts by over $4 billion. These reductions came at a time when these big banks were still suffering from lower mortgage lending and trading activity, both of which lead to lower earnings. They justified these reductions in the allowance balances by noting that credit quality and economic conditions had improved. This may be so, but it sure is great to have a cookie jar that might be tapped when a boost in earnings 8 -41 LO 2 is needed.

2 a DO IT! Bad Debt Expense Brule Co. has been in business five years. The unadjusted trial balance at the end of the current year shows: Accounts Receivable $30, 000 Dr. Sales Revenue $180, 000 Cr. Allowance for Doubtful Accounts $2, 000 Dr. Bad debts are estimated to be 10% of receivables. Prepare the entry to adjust Allowance for Doubtful Accounts. SOLUTION Bad Debt Expense 5, 000 * Allowance for Doubtful Accounts 5, 000 * [(10% x $30, 000) + $2, 000] 8 -42 LO 2

DISPOSING OF ACCOUNTS RECEIVABLES 8 -43

DISPOSING OF ACCOUNTS https: //www. youtube. com/results? search_query=jg+wentw RECEIVABLES orth+factoring Sale of Receivables to a Factor u Finance company or bank. u Buys receivables from businesses and then collects the payments directly from the customers. u Typically charges a commission to the company that is selling the receivables. u Fee ranges from 1% to 3% of the receivables purchased. https: //www. jgwentworth. com/ 8 -44 LO 2

How Factoring Works Business 8 -45 Source: http: //getfundedguide. com/get_money_now_by_factoring

Sale of Receivables to a Factor Illustration: Assume that Hendredon Furniture factors $600, 000 of receivables to Federal Factors assesses a service charge of 2% of the amount of receivables sold. The journal entry to record the sale by Hendredon Furniture is as follows. ($600, 000 x 2% = $12, 000) Cash 588, 000 Service Charge Expense Accounts Receivable 8 -46 12, 000 600, 000 LO 2

DISPOSING OF ACCTS RECEIVABLES 8 -47 LO 2

DISPOSING OF ACCTS RECEIVABLES National Credit Card Sales 8 -48 u Why do some businesses prefer Credit cards over A/R? u Advantages to retailer: ► Issuer does credit investigation of customer. ► Issuer maintains customer accounts. ► Issuer undertakes collection and absorbs losses. ► Receives cash more quickly. u Retailer pays card issuer a fee of 2 to 4% of the invoice price for its services. u Recorded the same as cash sales. LO 2

National Credit Card Sales Illustration: Morgan Marie purchases $1, 000 of compact discs for her restaurant from Sondgeroth Music Co. , and she charges this amount on her Visa First Bank Card. The service fee that First Bank charges Sondgeroth Music is 3%. Sondgeroth Music’s entry to record this transaction on March 22, 2017, is as follows. Cash 970 Service Charge Expense Sales Revenue 8 -49 30 1, 000 LO 2

ACCOUNTING ACROSS THE ORGANIZATION How Does a Credit Card Work? Suppose that you use a Visa card to purchase some new ties at Nordstrom. The salesperson swipes your card, which allows the information on the magnetic strip on the back of the card to be read. The salesperson then enters in the amount of the purchase. The machine contacts the Visa computer, which routes the call back to the bank that issued your Visa card. The issuing bank verifies that the account exists, that the card is not stolen, and that you have not exceeded your credit limit. At this point, the slip is printed, which you sign. Visa acts as the clearing agent for the transaction. It transfers funds from the issuing bank to Nordstrom’s bank account. Generally this transfer of funds, from sale to the receipt of funds in the merchant’s account, takes two to three days. In the meantime, Visa puts a pending charge on your account for the amount of the tie purchase; that amount counts immediately against your available credit limit. At the end of the billing period, Visa sends you an invoice (your credit card bill) which shows the various charges you made, and the amounts that Visa expended on your 8 -50 behalf, for the month. You then must “pay the piper” for your stylish LO 2 new ties.

2 b DO IT! Factoring Peter M. Kell Wholesalers Co. needs to raise $120, 000 in cash to safely cover next Friday’s employee payroll. Kell has reached its debt ceiling. Kell’s present balance of outstanding receivables totals $750, 000. Kell decides to factor $125, 000 of its receivables on September 7, 2017, to alleviate this cash crunch. Record the entry that Kell would make when it raises the needed cash. (Assume a 1% service charge. ) SOLUTION Cash Service Charge Expense Accounts Receivable * (1% x $125, 000) 8 -51 123, 750 1, 250 * 125, 000 LO 2

LEARNING OBJECTIVE 3 Explain how companies recognize, value, and dispose of notes receivable. Companies may grant credit in exchange for a promissory note. A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. Promissory notes may be used 1. when individuals and companies lend or borrow money, 2. when amount of transaction and credit period exceed normal limits, or 8 -52 3. in settlement of accounts receivable. LO 3

NOTES RECEIVABLE To the payee, the promissory note is a note receivable. To the maker, the promissory note is a note payable. 8 -53 ILLUSTRATION 8 -12 Promissory note LO 3

DETERMINING THE MATURITY DATE Maturity date of a promissory note may be stated in one of three ways: 1. On demand. 2. On a stated date. 3. At the end of a stated period of time. Note terms are expressed in: 8 -54 u Months u Days LO 3

COMPUTING INTEREST ILLUSTRATION 8 -13 Formula for computing interest When counting days, omit the date the note is issued, but include the due date. 8 -55 ILLUSTRATION 8 -14 Computation of interest LO 3

RECOGNIZING NOTES RECEIVABLE E 9 -10 Nov. 1 Loaned $15, 000 cash to Sally Givens on a 1 year, 10% note. Dec. 11 Sold goods to John Countryman, Inc. , receiving a $6, 750, 90 -day, 8% note. Dec. 16 Received a $4, 000, 6 -month, 9% note in exchange for Bob Reber’s outstanding accounts receivable. Nov. 1 Notes receivable Dec. 11 Cash 15, 000 Notes receivable 6, 750 Sales Dec. 16 15, 000 6, 750 Notes receivable 4, 000 Accounts receivable 8 -56 4, 000 LO 3

RECOGNIZING NOTES RECEIVABLE Illustration: Brent Company wrote a $1, 000, twomonth, 8% promissory note dated May 1, to settle an open account. Prepare entry would Wilma Company makes for the receipt of the note. May 1 Notes Receivable 1, 000 Accounts Receivable—Brent Company 8 -57 1, 000 LO 3

VALUING NOTES RECEIVABLE 8 -58 u Report short-term notes receivable at their cash (net) realizable value. u Estimation of cash realizable value and recording bad debt expense and related allowance are similar to accounts receivable. LO 3

INTERNATIONAL INSIGHT Can Fair Value Be Unfair? The FASB and the International Accounting Standards Board (IASB) are considering proposals for how to account for financial instruments. The FASB has proposed that loans and receivables be accounted for at their fair value (the amount they could currently be sold for), as are most investments. The FASB believes that this would provide a more accurate view of a company’s financial position. It might be especially useful as an early warning when a bank is in trouble because of poor -quality loans. But, banks argue that fair values are difficult to estimate accurately. They are also concerned that volatile fair values could cause large swings in a bank’s reported net income. Source: David Reilly, “Banks Face a Mark-to-Market Challenge, ” Wall Street Journal Online (March 15, 2010). 8 -59 LO 3

DISPOSING OF NOTES RECEIVABLE 1. Notes may be held to their maturity date. 2. Maker may default and payee must make an adjustment to the account. 3. Holder speeds up conversion to cash by selling the note receivable. 8 -60 LO 3

DISPOSING OF NOTES RECEIVABLE Honor of Notes Receivable A note is honored when its maker pays it in full at its maturity date. Dishonor of Notes Receivable A dishonored note is not paid in full at maturity. Dishonored note receivable is no longer negotiable. 8 -61 LO 3

Honor of Notes Receivable Illustration: Wolder Co. lends Higley Inc. $10, 000 on June 1, accepting a five-month, 9% interest note. If Wolder presents the note to Higley Inc. on November 1, the maturity date, Wolder’s entry to record the collection is: Nov. 1 Cash 10, 375 Notes Receivable 10, 000 Interest Revenue 375 ($10, 000 x 9% x 5/12 = $375) 8 -62 LO 3

Accrual of Interest Receivable Illustration: Suppose instead that Wolder Co. prepares financial statements as of September 30. The adjusting entry by Wolder is for four months ending Sept. 30. Illustration 815 Timeline of interest earned Sept. 1 Interest Receivable 300 Interest Revenue 300 ($10, 000 x 9% x 4/12 = $ 300) 8 -63 LO 3

Accrual of Interest Receivable Illustration: Prepare the entry Wolder’s would make to record the honoring of the Higley note on November 1. Nov. 1 Cash 10, 375 Notes Receivable Interest Revenue ($10, 000 × 9% × 1/12) 8 -64 10, 000 300 75 LO 3

DO IT! 3 Notes Receivable Gambit Stores accepts from Leonard Co. a $3, 400, 90 -day, 6% note dated May 10 in settlement of Leonard’s overdue open account. The note matures on August 8. What entry does Gambit make at the maturity date, assuming Leonard pays the note and interest in full at that time? SOLUTION Interest payable at maturity date = $3, 400 × 6% × 90/360 = $51 Cash 3, 451 8 -65 Notes Receivable 3, 400 Interest Revenue 51 LO 3

LEARNING OBJECTIVE 4 Describe the statement presentation of receivables and the principles of receivables management. Illustration 8 -16 Balance sheet presentation of receivables 8 -66 LO 4

MANAGING RECEIVABLES Managing accounts receivable involves five steps: 1. Determine to whom to extend credit. 2. Establish a payment period. 3. Monitor collections. 4. Evaluate the liquidity of receivables. 5. Accelerate cash receipts from receivables when necessary. 8 -67 LO 4

MANAGING RECEIVABLES Extending Credit 8 -68 u If the credit policy is too tight, you will lose sales. u If the credit policy is too loose, you may sell to customers who will pay either very late or not at all. u It is important to check references on potential new customers as well as periodically to check the financial health of continuing customers. LO 4

ACCOUNTING ACROSS THE ORGANIZATION Bad Information Can Lead to Bad Loans Many factors contributed to the recent credit crisis. One significant factor that resulted in many bad loans was a failure by lenders to investigate loan customers sufficiently. For example, Countrywide Financial Corporation wrote many loans under its “Fast and Easy” loan program. That program allowed borrowers to provide little or no documentation for their income or their assets. Other lenders had similar programs, which earned the nickname “liars’ loans. ” One study found that in these situations, 60% of applicants overstated their incomes by more than 50% in order to qualify for a loan. Critics of the banking industry say that because loan officers were compensated for loan volume, and because banks were selling the loans to investors rather than holding them, the lenders had little incentive to investigate the borrowers’ creditworthiness. Sources: Glenn R. Simpson and James R. Hagerty, “Countrywide Loss Focuses Attention on Underwriting, ” Wall Street Journal (April 30, 2008), p. B 1; and Michael Corkery, “Fraud Seen as Driver in Wave of Foreclosures, ” Wall Street Journal (December 21, 2007), p. A 1. 8 -69 LO 4

MANAGING RECEIVABLES Establishing a Payment Period 8 -70 u Companies should determine a required payment period and communicate that policy to their customers. u The payment period should be consistent with that of competitors. LO 4

MANAGING RECEIVABLES Monitoring Collections u u 8 -71 Companies should prepare an accounts receivable aging schedule at least monthly. ► Helps managers estimate the timing of future cash inflows. ► Provides information about the collection experience of the company and identifies problem accounts. Significant concentrations of credit risk must be discussed in the notes to its financial statements. LO 4

MANAGING RECEIVABLES Illustration 8 -18 Excerpt from Sketchers’ note on concentration of credit risk 8 -72 LO 4

EVALUATING LIQUIDITY OF RECEIVABLES Accounts Receivable Turnover: u Assess the liquidity of the receivables. u Measure the number of times, on average, a company collects receivables during the period. Average collection period: u Used to assess effectiveness of credit and collection policies. u 8 -73 Collection period should not exceed credit term period. LO 4

EVALUATING LIQUIDITY OF RECEIVABLES ILLUSTRATION 8 -19 Accounts receivable turnover and average collection period 8 -74 LO 4

ACCELERATING CASH RECEIPTS Three reasons for the sale of receivables: 1. Size. 2. Companies may sell receivables because they may be the only reasonable source of cash. 3. Billing and collection are often time-consuming and costly. 8 -75 LO 4

MANAGING RECEIVABLES Illustration 8 -20 Managing receivables 8 -76 LO 4

DO IT! 4 Analysis of Receivables In 2017, Lebron James Company had net credit sales of $923, 795 for the year. It had a beginning accounts receivable (net) balance of $38, 275 and an ending accounts receivable (net) balance of $35, 988. Compute Lebron James Company’s accounts receivable turnover and average collection period in days. SOLUTION 8 -77 LO 4

A Look at IFRS LEARNING OBJECTIVE 5 Compare the accounting for receivables under GAAP and IFRS. KEY POINTS Similarities 8 -78 u The recording of receivables, recognition of sales returns and allowances and sales discounts, and the allowance method to record bad debts are the same between GAAP and IFRS. u Both IFRS and GAAP often use the term impairment to indicate that a receivable or a percentage of receivables may not be collected. LO 5

A Look at IFRS Similarities u The FASB and IASB have worked to implement fair value measurement (the amount they currently could be sold for) for financial instruments, such as receivables. Both Boards have faced bitter opposition from various factions. Differences u 8 -79 Although IFRS implies that receivables with different characteristics should be reported separately, there is no standard that mandates this segregation. LO 5

A Look at IFRS Differences u 8 -80 IFRS and GAAP differ in the criteria used to determine how to record a factoring transaction. IFRS uses a combination approach focused on risks and rewards and loss of control. GAAP uses loss of control as the primary criterion. In addition, IFRS permits partial derecognition of receivables; GAAP does not. LO 5

A Look at IFRS LOOKING TO THE FUTURE Both the IASB and the FASB have indicated that they believe that financial statements would be more transparent and understandable if companies recorded and reported all financial instruments at fair value. That said, in IFRS 9, which was issued in 2009, the IASB created a split model, where some financial instruments are recorded at fair value, but other financial assets, such as loans and receivables, can be accounted for at amortized cost if certain criteria are met. Critics say that this can result in two companies with identical securities accounting for those securities in different ways. A proposal by the FASB would require that practically all equity instruments be reported at fair value, and that debt instruments may or may not be reported at fair value depending on whether certain criteria are met. 8 -81 LO 5

A Look at IFRS Practice Which of the following statements is false? a) Receivables include equity securities purchased by the company. b) Receivables include credit card receivables. c) Receivables include amounts owed by employees as a result of company loans to employees. d) Receivables include amounts resulting from transactions with customers. 8 -82 LO 5

A Look at IFRS Practice In recording a factoring transaction: a) IFRS focuses on loss of control. b) GAAP focuses on loss of control and risks and rewards. c) IFRS and GAAP allow partial derecognition. d) IFRS allows partial derecognition. 8 -83 LO 5

A Look at IFRS Practice Under IFRS: a) the entry to record estimated uncollected accounts is the same as GAAP. b) it is always acceptable to use the direct write-off method. c) all financial instruments are recorded at fair value. d) None of the above. 8 -84 LO 5

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