9 Receivables Principles of Financial Accounting 11 e

9 Receivables Principles of Financial Accounting, 11 e Reeve • Warren • Duchac

1 Describe the common classes of receivables. 9 -4 9 -2

1 The term receivables includes all money claims against other entities, including people, business firms, and other organizations. 9 -3

1 Accounts receivable are normally expected to be collected within a relatively short period, such as 30 or 60 days. 9 -4

1 Notes receivable are amounts that customers owe for which a formal, written instrument of credit has been issued. 9 -5

1 Other receivables expected to be collected within one year are classified as current assets. If collection is expected beyond one year, these receivables are classified as noncurrent assets and reported under the caption Investments. 9 -6

2 Describe the accounting for uncollectible receivables. 9 -9 9 -7

2 Factoring Companies often sell their receivables to other companies. This transaction is called factoring the receivables, and the buyer of the receivables is called a factor. 9 -8

2 Regardless of how careful a company is in granting credit, some credit sales will be uncollectible. The operating expense account is called bad debt expense, uncollectible accounts expense, or doubtful accounts expense. 9 -9

2 The direct write off method records bad debt expense only when an account is judged to be worthless. The allowance method records bad debt expense by estimating uncollectible accounts at the end of the accounting period. 9 -10

3 Describe the direct writeoff method of accounting for uncollectible receivables. 9 -13 9 -11

3 On May 10, a $4, 200 accounts receivable from D. L. Ross has been determined to be uncollectible. 9 -12

3 The amount written off is later collected on November 21. Reinstatement Entry Receipt of Cash Entry 9 -13

3 Example Exercise 9 -1 Direct Write-off Method Journalize the following transactions using the direct write-off method of accounting for uncollectible receivables. July 9 Received $1, 200 from Jay Burke and wrote off the remainder owed of $3, 900 as uncollectible. Oct. 11 Reinstated the account of Jay Burke and received $3, 900 cash in full payment. 9 -16 9 -14

3 Example Exercise 9 -1 (continued) Follow My Example 9 -1 July 9 Cash……………………. . 1, 200 Bad Debt Expense……………. . . 3, 900 Accounts Receivable—Jay Burke… Oct. 11 Accounts Receivable—Jay Burke………. . 5, 100 3, 900 Bad Debt Expense………………. . . . 11 Cash……………………… Accounts Receivable—Jay Burke… 3, 900 For Practice: PE 9 -1 A, PE 9 -1 B 9 -17 9 -15

4 Describe the allowance method of accounting for uncollectible receivables. 9 -18 9 -16

4 On December 31, Ex. Tone Company estimates that a total of $30, 000 of the $200, 000 balance of their Accounts Receivable will eventually be uncollectible. 9 -17

4 The net amount that is expected to be collected, $170, 000 ($200, 000 – $30, 000), is called the net realizable value (NRV). The adjusting entry reduces receivables to the NRV and matches uncollectible expenses with revenues. 9 -18

4 Write-Offs to the Allowance Account On January 21, John Parker’s account totaling $6, 000 is written off because it is uncollectible. 9 -19

4 9 -20

4 During 2010, Ex. Tone Company writes off $26, 750 of uncollectible accounts, including the $6, 000 account of John Parker. After posting all entries to writeoff uncollectible amounts, Allowance for Doubtful Accounts will have a credit balance of $3, 250 ($30, 000 – $26, 750). 9 -21

4 9 -22

4 If Ex. Tone Company had written off $32, 100 in accounts receivable during 2010, Allowance for Doubtful Accounts would have a debit balance of $2, 100. 9 -23

4 Nancy Smith’s account of $5, 000 which was written off on April 2 is later collected on June 10. Two entries are needed: one to reinstate Nancy Smith’s account and a second to record receipt of the cash. 9 -24

4 Reinstatement Entry Receipt of Cash Entry 9 -25

4 Example Exercise 9 -2 Allowance Method Journalize the following transactions using the allowance method of accounting for uncollectible receivables. July 9 Oct. 11 9 -28 9 -26 Received $1, 200 from Jay Burke and wrote off the remainder owed of $3, 900 as uncollectible. Reinstated the account of Jay Burke and received $3, 900 cash in full payment.

4 Example Exercise 9 -2 (continued) Follow My Example 9 -2 July 9 Cash……………………… 1, 200 Allowance for Doubtful Accounts………. . 3, 900 Accounts Receivable—Jay Burke……. Oct. 11 Accounts Receivable—Jay Burke………. . . 5, 100 3, 900 Allowance for Doubtful Accounts……. . 3, 900 11 Cash………………………. 3, 900 Accounts Receivable—Jay Burke……. . 3, 900 For Practice: PE 9 -2 A, PE 9 -2 B 9 -29 9 -27

4 Estimating Uncollectibles The allowance method uses two ways to estimate the amount debited to Bad Debt Expense. 1. Percent of sales method. 2. Analysis of receivables method. 9 -28

4 Percent of Sales Method If credit sales for the period are $3, 000 and it is estimated that ¾% will be uncollectible, Bad Debt Expense is debited for $22, 500 ($3, 000 ×. 0075). This approach disregards the balance of $3, 250 in the allowance account before the adjustment. 9 -29

4 Percent of Sales Method After the following adjusting entry on December 31 is posted, Allowance for Doubtful Accounts will have a balance of $25, 750 ($3, 250 + $22, 500). 9 -30

4 Percent of Sales Method 9 -31

4 Example Exercise 9 -3 Percent of Sales Method At the end of the current year, Accounts Receivable has a balance of $800, 000; Allowance for Doubtful Accounts has a credit balance of $7, 500; and net sales for the year total $3, 500, 000. Bad debt expense is estimated at ½ of 1% of net sales. Determine (a) the amount of the adjusting entry for uncollectible accounts; (b) the adjusted balances of Accounts Receivable, Allowance for Doubtful Accounts, and Bad Debt Expense; and (c) the net realizable value of accounts receivable. 9 -34 9 -32

4 Example Exercise 9 -3 (continued) Follow My Example 9 -3 (a) $17, 500 ($3, 500, 000 ×. 005) Adjusted Balance (b) Accounts Receivable…………………. $800, 000 Allowance for Doubtful Accounts ($7, 500 + $17, 500)………… 25, 000 Bad Debt Expense…………. . . 17, 500 (c) $775, 000 ($800, 000 – $25, 000) For Practice: PE 9 -3 A, PE 9 -3 B 9 -35 9 -33

4 Aging of Receivables The longer an account receivable is outstanding, the less likely it is that it will be collected. Basing the estimate of uncollectible accounts on how long specific amounts have been outstanding is called aging the receivables. 9 -34

4 Exhibit 1 9 -35 Aging of Receivables Schedule December 31, 2010

4 Percent of Sales Method The estimate based on receivables is compared to the balance in the allowance account to determine the amount of the adjusting entry. 9 -36

4 Percent of Sales Method Ex. Tone has an unadjusted credit balance of $3, 250 in Allowance for Doubtful Accounts. In Exhibit 1 the estimated uncollectible accounts totaled $26, 490. 9 -37

4 Percent of Sales Method The amount to be added to the allowance account is $23, 240 ($26, 490 – $3, 250). The adjusting entry is as follows: 9 -38

4 Percent of Sales Method 9 -39

4 Percent of Sales Method If the unadjusted balance of the allowance account had been a debit balance of $2, 100, the amount of the adjustment would have been $28, 590. Aug. 31 9 -40 Adjusting entry Adjusted balance

4 Example Exercise 9 -4 Analysis of Receivable Method At the end of the current year, Accounts Receivable has a balance of $800, 000; Allowance for Doubtful Accounts has a credit balance of $7, 500; and net sales for the year total $3, 500, 000. Using the aging method, the balance of Allowance for Doubtful Accounts is estimated as $30, 000. Determine (a) the amount of the adjusting entry for uncollectible accounts; (b) the adjusted balances of Accounts Receivable, Allowance for Doubtful Accounts, and Bad Debt Expense, and (c) the net realizable value of accounts receivable. 9 -44 9 -41

4 Example Exercise 9 -4 (continued) Follow My Example 9 -4 (a) $22, 500 ($30, 000 – $7, 500) Adjusted Balance (b) Accounts Receivable…………………. $800, 000 Allowance for Doubtful Accounts…. . 30, 000 Bad Debt Expense…………. . 22, 500 (c) $770, 000 ($800, 000 – $30, 000) For Practice: PE 9 -4 A, PE 9 -4 B 9 -45 9 -42

4 Exhibit 2 9 -43 Differences Between Estimation Methods

5 Compare the direct writeoff method and allowance method of accounting for uncollectible accounts. 9 -47 9 -44

5 Exhibit 3 Comparing Direct Write-Off and Allowance Methods (continued) 9 -45

5 Exhibit 3 Comparing Direct Write-Off and Allowance Methods (continued) Direct Write-Off Method 9 -46 Allowance Method

5 9 -47

6 Describe the accounting for notes receivable. 9 -51 9 -48

6 Characteristics of Notes Receivable A note receivable, or promissory note, is a written document containing a promise to pay: • The maker is the party making the promise to pay. • The payee is the party to whom the note is payable. • The face amount is the amount the note is written • for on its face. The issuance date is the date a note is issued. 9 -49 (continued)

6 Characteristics of Notes Receivable (continued) • The due date or maturity date is the date the note • • 9 -50 is to be paid. The term of the note is the amount of time between the issuance and due dates. The interest rate is that rate of interest that must be paid on the face amount for the term of the note.

6 Exhibit 4 9 -51 Promissory Note

6 What is the due date of a 90 day note dated March 16? Days in March Minus issuance date of note Days remaining in March Add days in April Add days in May Add days in June (due date of June 14) Term of note 9 -52 31 days 16 15 days 30 31 14 90 days

6 An Alternate Approach Total days in note Number of days in March Issue date of note Remaining days in March Number of days in April Number of days in May Residual days in June 90 days 31 March 16 – 15 days 75 days – 30 days 45 days – 31 days 14 days Answer: June 14 9 -53

6 9 -54

6 Accounting for Notes Receivable Received a $6, 000, 12%, 30 -day note dated November 21, 2010 in settlement of the account of W. A. Bunn Co. 9 -55

6 On December 21, when the note matures, the firm receives $6, 060 from W. A. Bunn Company ($6, 000 plus $60 interest). 9 -56

6 If W. A. Bunn Company fails to pay the note on the due date, it is considered a dishonored note receivable. The note and interest are transferred to the customer’s account. 9 -57

6 A 90 -day, 12% note dated December 1, 2010, is received from Crawford Company to settle its account, which has a balance of $4, 000. 9 -58

6 Assuming that the accounting period ends on December 31, an adjusting entry is required to record the accrued interest of $40 ($4, 000 × 0. 12 × 30/360). 9 -59

6 On March 1, 2011, $4, 120 is received for the note ($4, 000) and interest ($120). 9 -60

6 Example Exercise 9 -5 Note Receivable Same Day Surgery Center received a 120 -day, 6% note for $40, 000, dated March 14 from a patient on account. a. Determine the due date of the note. b. Determine the maturity value of the note. c. Journalize the entry to record the receipt of the payment of the note at maturity. 9 -64 9 -61

6 Example Exercise 9 -5 (continued) Follow My Example 9 -5 a. The due date of the note is July 12, determined as follows: March April May June July Total 17 days (31 – 14) 30 days 31 days 30 days 120 days b. $40, 800 [$40, 000 + ($40, 000 × 6% × 120/360)] c. Cash……………………. . . . Notes Receivable…………. . Interest Revenue…………. . . 40, 800 40, 000 800 For Practice: PE 9 -5 A, PE 9 -5 B 9 -65 9 -62

7 Describe the reporting of receivables on the balance sheet. 9 -66 9 -63

7 9 -64

Accounts Receivable Turnover The accounts receivable turnover measures how frequently during the year the accounts receivable are being converted to cash. Accounts Receivable Turnover 9 -65 = Net sales Average Accounts Receivable

Federal Express Corporation — 2006 2007 Net sales Accounts receivable Average accounts 2006 $22, 527 $21, 296 1, 429 2, 860 receivable 2, 145 *[($2, 860 + $2, 703)/2] Accounts Receivable = Turnover $21, 296 $2, 782 = 7. 7 9 -66 2005 * --$2, 703 2, 782

Federal Express Corporation — 2007 Net sales Accounts receivable Average accounts *[($1, 429 2006 $22, 527 $21, 296 1, 429 2, 860 receivable 2, 145 * + $2, 860)/2] Accounts Receivable = Turnover $22, 527 $2, 145 = 10. 5 9 -67 2005 --$2, 703 2, 782

Number of Days’ Sales in Receivables The number of days’ sales in receivables is an estimate of the length of time the accounts receivable have been outstanding. Number of Days’ Sales in Receivables 9 -68 = Average Accounts Receivable Average Daily Sales

Federal Express Corporation — 2006 2007 2006 Net sales $22, 527 $21, 296 Average accounts receivable 2, 145 2, 782 Average daily sales 61. 7 58. 3 * *$21, 296/365 Number of Days’ = $2, 782 58. 3 Sales in Receivables = 47. 7 9 -69

Federal Express Corporation — 2007 2006 Net sales $22, 527 $21, 296 Average accounts receivable 2, 145 2, 782 Average daily sales 61. 7 * 58. 3 *$22, 527/365 Number of Days’ = $2, 145 61. 7 Sales in Receivables = 34. 8 9 -70