Chapter F 7 Power Notes Receivables Learning Objectives

Chapter F 7 Power Notes Receivables Learning Objectives 1. Classification of Receivables 2. Internal Control of Receivables 3. Uncollectible Receivables 4. Uncollectibles – Allowance Method 5. Uncollectibles – Direct Write-Off Method 6. Characteristics of Notes Receivable 7. Accounting for Notes Receivable 8. Balance Sheet Presentation 9. Financial Analysis and Interpretation C 7 - 1

Chapter F 7 Power Notes Receivables Slide # Power Note Topics 2 4 6 15 20 21 22 • Receivables – Classification and Control • Uncollectibles – Direct Write-Off Method • Uncollectibles –Allowance Method • Accounting for Notes Receivable • Balance Sheet Presentation • Accounts Receivable Turnover • Number of Days’ Sales in Receivables Note: To select a topic, type the slide # and press Enter. C 7 - 2

Classification of Receivables 4 Accounts Receivable – used for selling merchandise or services on credit, and normally expected to be collected in a relatively short period. 4 Notes Receivable – used to grant credit on the basis of a formal instrument of credit, called a promissory note. 4 Other Receivables – interest receivable, taxes receivable, and receivables from officers or employees. C 7 - 3

Accounting for Uncollectible Accounts Receivable The Direct Write-Off Method • This method is not consistent with the matching principle. • Accounts that prove to be uncollectible are written off in the year they become worthless. • Uncollectible Accounts Expense is debited and Accounts Receivable is credited for each such transaction. C 7 - 4

Journal Entries – Direct Write-Off Method Date Description Debit Credit May. 10 Uncollectible Accts. Expense 420 Accts. Receivable - D. L. Ross 420 Write off uncollectible account of $420 Nov. 21 Accts. Receivable - D. L. Ross 420 Uncollectible Accts. Expense 420 Cash 420 Accts. Receivable - D. L. Ross Reinstate and collect prior account written off. 420 C 7 - 5

Accounting for Uncollectible Accounts Receivable The Allowance Method • This method is consistent with the matching principle. • Management makes an estimate each year of the portion of accounts receivable that may not be collectible. • Uncollectible Accounts Expense is debited and Allowance for Doubtful Accounts is credited. • Actual accounts that prove to be uncollectible are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable. C 7 - 6

Journal Entries – Allowance Method Date Description Debit Credit Dec. 31 Uncollectible Accts. Expense 4, 000 Allowance for Doubtful Acct. 4, 000 Estimated a total of $4, 000 will be uncollectible. Jan. 21 Allowance for Doubtful Accts. 610 Accts. Receivable - J. Parker Write off uncollectible account of $610. 610 Jun. 10 Accts. Receivable - J. Parker 610 Allowance for Doubtful Accts. 610 Accts. Receivable - J. Parker Reinstate and collect prior account written off. 610 Cash 610 C 7 - 7

Estimating Uncollectible Accounts Expense The allowance method uses two ways to estimate the amount debited to Uncollectible Accounts Expense 1. Estimate based on a percentage of sales. If credit sales for the period are $300, 000 and it is estimated that 1% will be uncollectible, the Uncollectible Accounts Expense is $3, 000. 2. Estimate based on analysis of receivables. If it is estimated that $3, 390 of the receivables will be uncollectible and the Allowance for Uncollectible Accounts is $510, the Uncollectible Accounts Expense is $2, 880 ($3, 390 – $510). C 7 - 8

Accounts Receivable Aging and Uncollectibles Days Past Due Not Customer 1 -30 Ashby & Co. B. T. Barr Brock Co. J. Zimmer Co. Total $ 150 610 $ 350 470 Balance 31 -60 61 -90 over Past Due 91 -180 181 -365 $ 150 $260 $ 470 160 $86, 300 160 $75, 000 $4, 000 $3, 100 $1, 900 $1, 200$800 $300 Total accounts receivable shown by age. C 7 - 9

Accounts Receivable Aging and Uncollectibles Days Past Due Not Customer 1 -30 Ashby & Co. B. T. Barr Brock Co. J. Zimmer Co. Total Uncollectibles PERCENT $ 150 610 $ 350 470 Balance 31 -60 61 -90 over Past Due 91 -180 181 -365 $ 150 $260 $ 470 160 $86, 300 160 $75, 000 $4, 000 $3, 100 $1, 900 $1, 200$800 $300 2% 5% 10% 20% 30% 50% 80% Uncollectible percentages based on experience and industry averages. C 7 - 10

Accounts Receivable Aging and Uncollectibles Days Past Due Not Customer 1 -30 Ashby & Co. B. T. Barr Brock Co. J. Zimmer Co. Total Uncollectibles PERCENT AMOUNT $ 150 610 $ 350 470 Balance 31 -60 61 -90 over Past Due 91 -180 181 -365 $ 150 $260 $ 470 160 $86, 300 160 $75, 000 $4, 000 $3, 100 $1, 900 $1, 200$800 $300 2% $3, 390 = $1, 500 5% 10% $200 $310 20% $380 30% $360 50% 80% $400 $240 C 7 - 11

Year-End Adjustment for Uncollectibles General Ledger Accounts Receivable A 86, 300 Allowance for Doubtful Accts. 510 A Balance Sheet Accounts receivable Less allowance for doubtful accounts Net accounts receivable $86, 300 3, 390 82, 910 A Balances before adjustment Uncollectible Accts. Expense C 7 - 12

Year-End Adjustment for Uncollectibles General Ledger Accounts Receivable A 86, 300 Allowance for Doubtful Accts. 510 A 2, 880 B Uncollectible Accts. Expense B Balance Sheet Accounts receivable Less allowance for doubtful accounts Net accounts receivable $86, 300 3, 390 82, 910 A Balances before adjustment B Year-end adjustment $3, 390 - $510 = $2, 880 C 7 - 13

Year-End Adjustment for Uncollectibles General Ledger Accounts Receivable A 86, 300 Allowance for Doubtful Accts. 510 A 2, 880 B 3, 390 C Uncollectible Accts. Expense B Balance Sheet Accounts receivable Less allowance for doubtful accounts Net accounts receivable $86, 300 3, 390 C 82, 910 A Balances before adjustment B Year-end adjustment $3, 390 - $510 = $2, 880 C Balance after adjustment C 7 - 14

Characteristics of Notes Receivable A promissory note is a written document containing a promise to pay: 4 a specific amount of money (principal) 4 to a specific person or company (payee) 4 at a specific place 4 on a specific date or upon demand 4 plus interest at a specific percentage of the principal (face) amount per year C 7 - 15

Calculating Interest and Maturity Value We received a $2, 500, 10%, 90 -day note dated March 16, 2000. Interest Calculation Principal x Rate x Time = Interest $2, 500 x 10% x 90 /360 = $62. 50 Maturity Value Calculation Principal + Interest = Maturity Value $2, 500 + $62. 50 = $2, 562. 50 C 7 - 16

Accounting for Notes Receivable Date Description Debit Credit Nov. 21 Notes Receivable 6, 000 Accts. Receivable - Bunn Co. Received a $6, 000, 30 -day, 12% note. 6, 000 Dec. 21 Cash 6, 060 Notes Receivable Collected amount due on note dated November 21. 6, 000 Interest Revenue 60 Principal + Interest = Maturity Value $6, 000 + ($6, 000 x 12% x 30 / 360) = $6, 060 C 7 - 17

Understanding the 360 -Day Year 4 In commercial transactions it is traditional to use a 360 -day year. 4 The historic rationale for this procedure was ease of calculation which made sense before the computer and calculator age. 4 Why does this practice continue when most small calculators and desktop computers can present complex interest calculations in a few seconds? C 7 - 18

Another Look at the 360 -Day Year 1. Assume a $100, 000 note dated June 1 for 90 days at an interest rate of 12 percent. The textbook calculation is as follows: $100, 000 x (12 / 100) x (90 /360) = $3, 000. 00 2. A more precise calculation is as follows: $100, 000 x (12 / 100) x (90 /365) = $2, 958. 90 3. When large sums are involved the 360 -day method (known as ordinary interest or banker’s rule) yields significantly more interest to the lender. It is used by banks and commercial organizations. 4. The second method (known as exact interest) is used by the federal government and the Federal Reserve System. C 7 - 19

Crabtree Co. Balance Sheet December 31, 20 -Assets Current assets: Cash $119, 500 Notes receivable 250, 000 Accounts receivable $445, 000 Less allowance for doubtful accounts 15, 000 430, 000 Interest receivable 14, 500 C 7 - 20

Solvency Measures — The Short-Term Creditor Accounts Receivable Turnover Net sales on account Accounts receivable (net): Beginning of year End of year Total Average Accts. receivable turnover 2000 1999 $1, 498, 000 $1, 200, 000 $ 120, 000 $ 140, 000 115, 500 120, 000 $ 235, 000 $ 260, 000 $ 117, 500 $ 130, 000 12. 7 times 9. 2 times Use: To assess the efficiency in collecting receivables and in the management of credit. C 7 - 21

Solvency Measures — The Short-Term Creditor Number of Days’ Sales in Receivables Net sales on account Accounts receivable (net): Beginning of year End of year Total Average collection period 2000 1999 $1, 498, 000 $1, 200, 000 $ 120, 000 $ 140, 000 115, 500 120, 000 $ 235, 000 $ 260, 000 $ 117, 500 $ 130, 000 28 days 36 days Use: To assess the efficiency in collecting receivables and in the management of credit. C 7 - 22

Chapter F 7 Power Notes Receivables This is the last slide in Chapter F 7. Note: To see the topic slide, type 2 and press Enter. C 7 - 23