Chapter 8 Accounting for Receivables ACCT 100 Chapter

Chapter 8 Accounting for Receivables ACCT 100

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

Accounts Receivable and Notes 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 3

A. Accounts Receivable (A/R) (trade receivables): An oral promise for future cash receipt as a result of sales; a current asset. n 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 4

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 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 Total $10, 000 Short-Term Investments & Receivables 5

Uncollectible Accounts (Bad Debts) n n 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 6

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 A/R - A Company Short-Term Investments & Receivables 200 7

The Accounting for the Uncollectible Accounts (Continued) If $100 of the B/D recovered: A/R Cash n n Allowance for Uncollectible Accounts A/R 100 100 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 8

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 9

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 10

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 Allowance for uncollectible accounts Short-Term Investments & Receivables 200 11

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 12

Estimation of B/D Expense n 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 13

Credit-Card Sales n 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 14

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). n Disadvantages of credit-card sales to customers, companies (the sellers) and the credit-card companies: Short-Term Investments & Receivables 15

Accounting for Credit Card Sales – Credit Cards Issued by a Financial Company: n 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 Service Charge Expense Sales Revenue Short-Term Investments & Receivables 98 2 100 16

B. Accounting for Notes Receivable n n 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 17

B. Accounting for Notes Receivable (Continued) n n n 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 18

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 19

Example (a): (Continued) 12/31/08 Interest Receivable 30 Interest Revenue 3/31/09 Cash 30 1, 060 Note Receivable -- Greenway Interest Receivable Interest Revenue Short-Term Investments & Receivables 1, 000 30 30 20

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, 000 x 12% x 90/360 = $360 21

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 22

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 23

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

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

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 26

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 27

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 28