Chapter 8 1 Reporting and Analyzing Receivables Chapter

Chapter 8 -1

Reporting and Analyzing Receivables Chapter 8 -2 Financial Accounting, Fifth Edition

Study Objectives 1. Identify the different types of receivables. 2. Explain how accounts receivable are recognized in the accounts. 3. Describe the methods used to account for bad debts. 4. Compute the interest on notes receivable. 5. Describe the entries to record the disposition of notes receivable. 6. Explain the statement presentation of receivables. 7. Describe the principles of sound accounts receivable management. 8. Identify ratios to analyze a company’s receivables. 9. Describe methods to accelerate the receipt of cash from receivables. Chapter 8 -3

Reporting and Analyzing Receivables Types of Receivables Accounts Receivable Notes Receivable Accounts receivable Notes receivable Other receivables Recognizing accounts receivable Valuing accounts receivable Determining maturity date Computing interest Recognizing notes receivable Valuing notes receivable Disposing of notes receivable Chapter 8 -4 Statement Presentation of Receivables Balance sheet and notes Income statement Managing Receivables Extending credit Establishing a payment period Monitoring collections Evaluating liquidity of receivables Accelerating cash receipts

Types of Receivables Amounts due from individuals and other companies that are expected to be collected in cash. Amounts owed by customers that result from the sale of goods and services. Chapter 8 -5 Claims for which formal instruments of credit are issued as proof of debt. “Nontrade” (interest, loans to officers, advances to employees, and income taxes refundable). SO 1 Identify the different types of receivables.

Accounts Receivable Two accounting issues: 1. Recognizing accounts receivable. 2. Valuing accounts receivable. Recognizing Accounts Receivable A service organization records a receivable when it provides service on account. A merchandiser records accounts receivable at the point of sale of merchandise on account. Chapter 8 -6 SO 2 Explain how accounts receivable are recognized in the accounts.

Accounts Receivable Illustration: Assume that you use your JCPenney Company credit card to purchase clothing with a sales price of $300. Assuming that you owe $300 at the end of the month, and JCPenney charges 1. 5% per month on the balance due. Prepare the entry to record the sale and the adjusting entry to record interest revenue. Chapter 8 -7 SO 2 Explain how companies recognize accounts receivable.

Accounts Receivable Valuing Accounts Receivables Classification Valuation (net realizable value) Uncollectible Accounts Receivable Sales on account raise the possibility of accounts not being collected Chapter 8 -8 SO 3 Describe the methods used to account for bad debts.

Valuing Accounts Receivable Methods of Accounting for Uncollectible Accounts Direct Write-Off Theoretically undesirable: no matching. receivable not stated at net realizable value. not acceptable for financial reporting. Chapter 8 -9 Allowance Method Losses are estimated: better matching. receivable stated at net realizable value. required by GAAP. SO 3 Describe the methods used to account for bad debts.

Accounting for A/R and Bad Debts How are these accounts presented on the Balance Sheet? Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 500 25 End. Chapter 8 -10

Assets Current Assets: Cash Accounts receivable Less allowance for doubtful accounts Inventory Prepaids Total current assets Fixed Assets: Office equipment Furniture & fixtures Less: Accumulated depreciation Total fixed assets Total Assets Chapter 8 -11 $ 346 500 25 475 812 _ 40 1, 673 5, 679 6, 600 (3, 735) 8, 544 $10, 217

Assets Current Assets: Cash Accounts receivable, net of $25 allowance for doubtful accounts Inventory Prepaids Total current assets Fixed Assets: Office equipment Furniture & fixtures Less: Accumulated depreciation Total fixed assets Total Assets Chapter 8 -12 $ 346 475 812 _ 40 1, 673 5, 679 6, 600 (3, 735) 8, 544 $10, 217

Accounting for A/R and Bad Debts Journal entry for credit sale of $100? Accounts receivable 100 Sales Accounts Receivable 100 Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 500 25 End. Chapter 8 -13

Accounting for A/R and Bad Debts Journal entry for credit sale of $100? Accounts receivable 100 Sales Accounts Receivable Beg. 500 Sale 100 End. 600 Chapter 8 -14 100 Allowance for Doubtful Accounts 25 Beg. 25 End.

Accounting for A/R and Bad Debts Collected of $333 on account? Cash Accounts receivable Accounts Receivable Beg. 500 Sale 100 End. 600 Chapter 8 -15 333 Allowance for Doubtful Accounts 25 Beg. 25 End.

Accounting for A/R and Bad Debts Collected of $333 on account? Cash Accounts receivable Accounts Receivable Beg. 500 Sale 100 End. 267 Chapter 8 -16 333 333 Allowance for Doubtful Accounts 25 Beg. 25 End. Coll.

Accounting for A/R and Bad Debts Adjustment of $15 for estimated Bad-Debts? Bad debt expense 15 Allowance for Doubtful Accounts Receivable Beg. 500 Sale 100 End. 267 Chapter 8 -17 333 15 Allowance for Doubtful Accounts 25 Beg. 25 End. Coll.

Accounting for A/R and Bad Debts Adjustment of $15 for estimated Bad-Debts? Bad debt expense 15 Allowance for Doubtful Accounts Receivable Beg. 500 Sale 100 End. 267 Chapter 8 -18 333 Coll. 15 Allowance for Doubtful Accounts 25 Beg. 15 Est. 40 End.

Accounting for A/R and Bad Debts Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts 10 Accounts receivable Accounts Receivable Beg. 500 Sale 100 End. 267 Chapter 8 -19 333 Coll. 10 Allowance for Doubtful Accounts 25 Beg. 15 Est. 40 End.

Accounting for A/R and Bad Debts Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts 10 Accounts receivable Accounts Receivable Beg. 500 Sale 100 End. Chapter 8 -20 257 333 Coll. 10 W/O 10 Allowance for Doubtful Accounts W/O 25 Beg. 15 Est. 30 End. 10

Assets Current Assets: Cash Accounts receivable, net of $30 allowance for doubtful accounts Inventory Prepaids Total current assets Fixed Assets: Office equipment Furniture & fixtures Less: Accumulated depreciation Total fixed assets Total Assets Chapter 8 -21 $ 346 227 812 _ 40 1, 673 5, 679 6, 600 (3, 735) 8, 544 $10, 217

Valuing Accounts Receivable Direct Write-off Method for Uncollectible Accounts Illustration: Assume, for example, that Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. Warden’s entry is: Chapter 8 -22 SO 3 Describe the methods used to account for bad debts.

Valuation of Accounts Receivable Methods of Accounting for Uncollectible Accounts Direct Write-Off Theoretically undesirable: No matching Receivable not stated at net realizable value Not GAAP Chapter 8 -23 Allowance Method Losses are Estimated: Percentage-of-sales Percentage-ofreceivables GAAP LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable Income Statement Approach Balance Sheet Approach Chapter 8 -24 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable Percentage-of-Sales Approach - matches costs with revenues because it relates the charge to the period in which a company records the sale. Appropriate if there is a fairly stable relationship between previous years’ credit sales and bad debts. Chapter 8 -25 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable Percentage-of-Sales Approach Illustration: Chad Shumway Corp. estimates from past experience that about 2 percent of credit sales become uncollectible. If Chad Shumway has credit sales of $400, 000 in 2010, it records bad debt expense as follows. Chapter 8 -26 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable Percentage-of-Receivables Approach Ø not matching. Ø reports receivables at net realizable value. Companies may apply this method using Ø one composite rate, or Ø an aging schedule of accounts receivable. Chapter 8 -27 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable What entry would Wilson make assuming that no balance existed in the allowance account? Chapter 8 -28 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment? Chapter 8 -29 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable E 7 -7 (Recording Bad Debts) Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (a) 1% of net sales and (b) 5% of accounts receivable. Chapter 8 -30 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable E 7 -7 (Recording Bad Debts) Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (a) 1% of net sales. Chapter 8 -31 LO 5

Uncollectible Accounts Receivable E 7 -7 (Recording Bad Debts) Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 5% of accounts receivable. Chapter 8 -32 LO 5

Uncollectible Accounts Receivable Summary Percentage of Sales approach: Bad debt expense estimate is related to a nominal account (Sales), any balance in the allowance account is ignored. Achieves a proper matching of cost and revenues. Percentage of Receivables approach: Results in a more accurate valuation of receivables on the balance sheet. Method may also be applied using an aging schedule. Chapter 8 -33 LO 5 Explain accounting issues related to valuation of accounts receivable.

Valuing Accounts Receivable Illustration: Assume that Hampson Furniture has credit sales of $1, 200, 000 in 2010, of which $200, 000 remains uncollected at December 31. The credit manager estimates that $12, 000 of these sales will prove uncollectible. Dec. 31 Chapter 8 -34 SO 3 Describe the methods used to account for bad debts.

Valuing Accounts Receivable Illustration 8 -3 Presentation of allowance for doubtful accounts Chapter 8 -35 SO 3 Describe the methods used to account for bad debts.

Valuing Accounts Receivable Recording Write-off of an Uncollectible Account Illustration: Assume that the vice-president of finance of Hampson Furniture on March 1, 2011, authorizes a writeoff of the $500 balance owed by R. A. Ware. The entry to record the write-off is: Mar. 1 Illustration 8 -4 Chapter 8 -36 SO 3 Describe the methods used to account for bad debts.

Valuing Accounts Receivable Recovery of an Uncollectible Account Illustration: Assume that on July 1, R. A. Ware pays the $500 amount that Hampson Furniture had written off on March 1. Hampson makes these entries: Jul. 1 1 Chapter 8 -37 SO 3 Describe the methods used to account for bad debts.

Valuing Accounts Receivable Estimating the Allowance Under the percentage of receivables basis, management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts. Chapter 8 -38 SO 3 Describe the methods used to account for bad debts.

Valuing Accounts Receivable Under percentage of receivables basis, management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts. Illustration 8 -6 Chapter 8 -39 SO 3 Describe the methods used to account for bad debts.

Valuing Accounts Receivable 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. 31 Illustration 8 -7 Bad debts accounts after posting Chapter 8 -40

Valuing Accounts Receivable Illustration 8 -8 Note disclosure of accounts receivable Chapter 8 -41 SO 3 Describe the methods used to account for bad debts.

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 3. in settlement of accounts receivable. Chapter 8 -42

Notes Receivable To the Payee, the promissory note is a note receivable. To the Maker, the promissory note is a note payable. Illustration 8 -9 Chapter 8 -43

Notes Receivable Determining the Maturity Date Note expressed in terms of Months Days Computing Interest Chapter 8 -44 Illustration 8 -10 SO 4 Compute the interest on notes receivable.

Notes Receivable Computing Interest When counting days, omit the date the note is issued, but include the due date. Illustration 8 -11 Chapter 8 -45 SO 4 Compute the interest on notes receivable.

Notes Receivable Recognizing Notes Receivable Illustration: Assuming that Brent Company wrote a $1, 000, two-month, 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 Chapter 8 -46 SO 4 Compute the interest on notes receivable.

Notes Receivable Valuing Notes Receivable Like accounts receivable, companies report shortterm notes receivable at their cash (net) realizable value. Estimation of cash realizable value and bad debts expense are done similarly to accounts receivable. Allowance for Doubtful Accounts is used. Chapter 8 -47 SO 4 Compute the interest on notes receivable.

Notes Receivable 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. Chapter 8 -48 SO 5 Describe the entries to record the disposition of notes receivable.

Notes Receivable 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. Chapter 8 -49 SO 5 Describe the entries to record the disposition of notes receivable.

Notes Receivable Honor of Notes Receivable Illustration: Assume that 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 Chapter 8 -50 SO 5 Describe the entries to record the disposition of notes receivable.

Notes Receivable Accrual of Interest Illustration: Suppose instead that Wolder Co. prepares financial statements as of September 30. Prepare the adjusting entry by Wolder is for four months ending Sept. 30 Interest receivable Interest revenue 300 ($10, 000 x 9% x 4/12 = $ 300) Chapter 8 -51 SO 5 Describe the entries to record the disposition of notes receivable.

Notes Receivable Honor of Notes Receivable Illustration: Prepare the entry Wolder’s would make to record the honoring of the Higley note on November 1. Nov. 1 Cash Notes receivable Interest revenue Chapter 8 -52 10, 375 10, 000 300 75 SO 5 Describe the entries to record the disposition of notes receivable.

Financial Statement Presentation Illustration 8 -12 Balance sheet presentation of receivables Chapter 8 -53 SO 6 Explain the statement presentation of receivables.

Financial Statement Presentation Chapter 8 -54 SO 9 Describe methods to accelerate the receipt of cash from receivables.

Financial Statement Presentation Evaluating Liquidity of Receivables Illustration 8 -14 Chapter 8 -55 SO 8 Identify ratios to analyze a company’s receivables.

Financial Statement Presentation Evaluating Liquidity of Receivables Accounts Receivable Turnover is used to: Assess the liquidity of the receivables. Measure the number of times, on average, a company collects receivables during the period. Variant of the accounts receivable turnover ratio is average collection period in terms of days. Used to assess effectiveness of credit and collection policies. Collection period should not exceed credit term period. Chapter 8 -56 SO 8 Identify ratios to analyze a company’s receivables.

Financial Statement Presentation 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. Chapter 8 -57 SO 9 Describe methods to accelerate the receipt of cash from receivables.

Financial Statement Presentation National Credit Card Sales Three parties involved when credit cards are used. 1. credit card issuer, 2. retailer, and 3. customer. The retailer pays the credit card issuer a fee of 2% to 4% of the invoice price for its services. Chapter 8 -58 SO 9 Describe methods to accelerate the receipt of cash from receivables.

Financial Statement Presentation 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%. Chapter 8 -59 SO 9 Describe methods to accelerate the receipt of cash from receivables.

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