Module 5 Accounts Receivable and Accounts Payable Learning

Module 5 Accounts Receivable and Accounts Payable

Learning Objectives Explain Accounts Receivable. Describe and illustrate entries for the recording of Accounts Receivable. Illustrate and practice allowance methods to value Accounts Receivable. Illustrate and practice estimation methods to value Accounts Receivable. Percent of sales Percent of Accounts Receivable Illustrate and practice the Direct write off method. Describe accounting for short term Notes Receivables. Discuss converting Short Term notes to cash before maturity Discuss AR Turnover and Days Sales uncollected Ratios. Explain Accounts Payable. Describe classification of Liabilities. Run an SAP demonstration. Practice making receivable and payable entries in SAP 2007 / SAP University Alliances Introductory Accounting

Accounts Receivable Arise from credit sales to customers. Often referred to as Trade Receivables. Other receivables include interest receivable, rent receivable, tax refund receivable. SAP 2007 / SAP University Alliances Introductory Accounting

Accounts Receivable Companies selling on account need to: Maintain a separate account for each customer. Account for bad debts. SAP 2007 / SAP University Alliances Introductory Accounting

Accounts Receivable Example: Sample has the following Accounts Receivable balances at June 30: General Ledger Accounts Receivable bal. 5, 000 Control account balances with total of subledger balances. A/R Subledger Jones Co bal. 2, 000 Store ABC bal. 3, 000 Total 5, 000 SAP 2007 / SAP University Alliances Introductory Accounting

Accounts Receivable Example: Credit sale for $550 Accounts Receivable- Store ABC Sales 550 General Ledger Accounts Receivable bal. 5, 000 A/R Subledger Jones Co bal. 2, 000 550 bal. 5, 550 Store ABC Control account balances with total of subledger balances. SAP 2007 / SAP University Alliances bal. 3, 000 550 bal. 3, 550 Total 5, 550 Introductory Accounting

Accounts Receivable Example: Collection of account Cash 850 Accounts Receivable-Jones Co General Ledger Accounts Receivable bal. 5, 000 550 A/R Subledger Jones Co bal. 2, 000 850 850 bal. 1, 150 bal. 4, 700 Store ABC Control account balances with total of subledger balances. SAP 2007 / SAP University Alliances bal. 3, 000 550 bal. 3, 550 Total 4, 700 Introductory Accounting

Non-Bank Credit Cards Retailers often accept non-bank credit cards. The retailers mail the receipts and await payment from the credit card company. These companies charge the retailer a fee and deduct it from the amount owing. SAP 2007 / SAP University Alliances Introductory Accounting

Valuing Accounts Receivable Some customers who are granted credit do not pay what they promised. The accounts of these customers are called uncollectible accounts or bad debts. SAP 2007 / SAP University Alliances Introductory Accounting

Valuing Accounts Receivable Methods for accounting for uncollectible accounts: • Allowance method (satisfies GAAP) • Direct method (does not satisfy GAAP) SAP 2007 / SAP University Alliances Introductory Accounting

Allowance Method Satisfies matching principle by matching expected bad debts losses (expenses) with revenues that produced the losses. Adjustments for bad debts are made at the end of the accounting period. Adjustments use a contra-asset account called Allowance for Doubtful Accounts. SAP 2007 / SAP University Alliances Introductory Accounting

Recording Estimated Bad Debt Expense — Allowance Method Example: The estimated bad debts for Jones Co is $1, 000. • The period entry to record bad debts is: Bad Debts Expense 1, 000 Allowance for Doubtful Accounts 1, 000 An allowance account is used since we do not know which accounts will be uncollectible. SAP 2007 / SAP University Alliances Introductory Accounting

Writing Off a Bad Debt — Allowance Method Example: A specific customer’s account (Ron Trent) is considered uncollectible. • The entry to record the write-off is: Allowance for Doubtful Accounts Receivable — Ron Trent 880 Note that there is no expense recorded when the account is written off. The estimated expense was previously recorded. SAP 2007 / SAP University Alliances Introductory Accounting

General Ledger Balances Bad Debts Expense 1, 000 Allowance for Doubtful Accounts To record estimated bad debts Allowance for Doubtful Accounts Receivable — Ron Trent To write off an uncollectible account Accounts Receivable bal. 17, 120 SAP 2007 / SAP University Alliances 880 Allow. For Doubtful Accts. bal. 18, 000 1, 000 880 bal. 120 Introductory Accounting

Realizable Value Before and After Write-off Accounts Receivable Allow. For Doubtful Accts. bal. 18, 000 1, 000 880 bal. 17, 120 880 bal. 120 Before Write-off Accounts Receivable Less: Allowance for Doubtful Accounts Est. Realizable Accounts Receivable SAP 2007 / SAP University Alliances After Write-off $18, 000 $17, 120 1, 000 120 $17, 000 Introductory Accounting

Recovery of a Bad Debt. Allowance Method Example: Ron Trent pays his account in full after the account had been written off. Entries are needed to record the reinstatement of the account and the subsequent collection. The entries are: Accounts Receivable-Ron Trent 880 Allowance for Doubtful Accounts 880 To reinstate customer’s account. Cash Accounts Receivable-Ron Trent To record collection of account. SAP 2007 / SAP University Alliances 880 Introductory Accounting

Estimating Bad Debt Expense Acceptable Methods: - Percent of Sales Approach - Accounts Receivable Approach SAP 2007 / SAP University Alliances Introductory Accounting

Percent of Sales Approach Also referred to as the Income Statement Approach. Based on idea that a percentage of a company’s sales are uncollectible. The primary focus is on estimating bad debts expense for the income statement. SAP 2007 / SAP University Alliances Introductory Accounting

Percent of Sales Approach Under this approach, bad debts expense is computed as follows: Current Period Credit Sales x Estimated Bad Debt % = Estimated Bad Debts Expense SAP 2007 / SAP University Alliances Introductory Accounting

Percent of Sales Approach Example: BCD Company has sales of $500, 000 and estimates 0. 5% of those sales will not be collectible. Estimated Bad Debts Expense is calculated as $2, 500 ($500, 000 x. 5%). The period end adjusting entry would be: Bad Debts Expense 2, 500 Allowance for Doubtful Accounts 2, 500 To record estimated bad debts SAP 2007 / SAP University Alliances Introductory Accounting

Percent of Accounts Receivable Approach This method assumes that a percentage of Accounts Receivable is uncollectible. Using this method, we compute the estimate of the Allowance for Doubtful Accounts as: Year-end Accounts Receivable x Bad Debt % SAP 2007 / SAP University Alliances Introductory Accounting

Percent of Accounts Receivable Approach Bad Debts Expense is computed as: Estimated adjusted balance in Allowance for Doubtful Accounts - Unadjusted year-end balance in Allowance for Doubtful Accounts = Estimated Bad Debts Expense The objective for the entry is to make the Allowance account balance equal to the portion of outstanding Accounts Receivable estimated to be uncollectible. SAP 2007 / SAP University Alliances Introductory Accounting

Aging of Accounts Receivable Approach Assumes that the older the Account Receivable the more likely is will become uncollectible. Steps: 1. Group accounts based on how much time has passed since they were created. 2. Estimate rates of uncollectibility for each group. 3. Apply rate to each group to get the required balance for the Allowance account. SAP 2007 / SAP University Alliances Introductory Accounting

Aging of Accounts Receivable Example: At December 31, the receivables for ABC Co were classified as follows: SAP 2007 / SAP University Alliances Introductory Accounting

Aging of Accounts Receivable Using estimated bad debt percentages, ABC Co would calculate the estimated uncollectible amount as follows: SAP 2007 / SAP University Alliances Introductory Accounting

Aging of Accounts Receivable ABC Co’s unadjusted balance in the allowance account is a debit Allowance for Doubtful Accounts Unadj. bal. 700 of $700. The previous 3, 050 computation shows the desired Adj. bal. 2, 350 balance is $2, 350; therefore, the adjusting entry is for $2, 350 + 700 = $3, 050. Bad Debts Expense 3, 050 Allowance for Doubtful Accounts To record estimated bad debts SAP 2007 / SAP University Alliances Introductory Accounting 3, 050

Direct Write-off Method Sometimes used as an alternative to the Allowance method when uncollectible accounts are not material. The loss from an uncollectible account is recorded when it is determined to be uncollectible. This method does not satisfy the principles of matching and conservatism. SAP 2007 / SAP University Alliances Introductory Accounting

Writing Off a Bad Debt — Direct Write-off Method Example: A specific customer’s account (Ron Trent) is considered uncollectible. The entry to record the write-off is: Bad Debts Expense 450 Accounts Receivable—Ron Trent 450 SAP 2007 / SAP University Alliances Introductory Accounting

Short-Term Notes Receivable Promissory Note A written promise to pay a specified amount of money either on demand or at a definite future date. Short-Term Note Receivable A promissory note that becomes due within 12 months or within the firm’s operating cycle. SAP 2007 / SAP University Alliances Introductory Accounting

Short-Term Notes Receivable Usually interest bearing. Interest rates are stated on an annual basis. Interest is calculated as follows: Principal Interest = of the note SAP 2007 / SAP University Alliances X Annual interest rate X Time expressed in years Introductory Accounting

Short-Term Notes Receivable Example: Sample Co receives a $2, 000, 90 -day, 10% promissory note at the time of a sale. The entry to record the transaction would be: Notes Receivable Sales SAP 2007 / SAP University Alliances 2, 000 Introductory Accounting

Short-Term Notes Receivable Example: On December 1, Sample Co receives a $5, 000, 60 -day, 10% promissory note and $1, 000 cash to settle a $6, 000 past-due account. The entry to record the transaction would be: Cash 1, 000 Notes Receivable 5, 000 Accounts Receivable SAP 2007 / SAP University Alliances 6, 000 Introductory Accounting

Short-Term Notes Receivable On December 31, 30 days after the note is issued, an accrual for interest earned on the note is made. The entry to record the accrual would be: Interest Receivable Interest Revenue (5, 000 x 10% x 30/365) 41. 10 On January 30, the 60 -day note matures. The entry to record the honouring of the note would be: Cash 5, 082. 20 Interest Revenue Interest Receivable Notes Receivable (5, 000 x 10% x 60/365)= 82. 20 SAP 2007 / SAP University Alliances 41. 10 5, 000. 00 Introductory Accounting

Converting Receivables to Cash Before Maturity Receivables are sometimes converted into cash before maturity since: • Companies may need the cash. • Companies do not want to be involved in the collection activities. SAP 2007 / SAP University Alliances Introductory Accounting

Converting Receivables to Cash Before Maturity Conversion of receivables into cash is accomplished by either: • Selling them to a factor • Pledging them as loan security. SAP 2007 / SAP University Alliances Introductory Accounting

Ratios The quality (likelihood of collection) and liquidity (speed of collection) of a company’s receivables may be assessed by calculating: • 1. Accounts receivable turnover ratio • 2. Days’ sales uncollected SAP 2007 / SAP University Alliances Introductory Accounting

Ratios Accounts receivable turnover = Days’ sales Uncollected SAP 2007 / SAP University Alliances = Net Credit Sales Average accounts receivable Net sales Introductory Accounting x 365

Accounts Payable SAP 2007 / SAP University Alliances Introductory Accounting

Accounts Payable Arise from credit purchases from vendors Often referred to as Trade Payables. Companies buying on account need to Maintain a separate account for each vendor. SAP 2007 / SAP University Alliances Introductory Accounting

Accounts Payable Example: Sample has the following Accounts Payable balances at March 30: General Ledger Accounts Payable bal. 5, 000 A/P Subledger Jones Co bal. 2, 000 Store ABC Control account balances with total of subledger balances. SAP 2007 / SAP University Alliances bal. 3, 000 Total 5, 000 Introductory Accounting

Accounts Payable Example: Credit purchase for $550. Purchases 550 Accounts payable A/P - Store ABC 550 General Ledger Subledger Accounts Payable bal. 5, 000 Jones Co bal. 2, 000 550 bal. 5, 550 Store ABC Control account balances with total of subledger balances. SAP 2007 / SAP University Alliances bal. 3, 000 550 bal. 3, 550 Total 5, 550 Introductory Accounting

Accounts Payable Example: Payment on account Accounts Payable - Jones Co Cash General Ledger 850 A/R Subledger Accounts Payable Jones Co bal. 5, 000 850 550 bal. 2, 000 850 bal. 1, 150 bal. 4, 700 Store ABC Control account balances with total of subledger balances. SAP 2007 / SAP University Alliances bal. 3, 000 550 bal. 3, 550 Total 4, 700 Introductory Accounting

Liabilities A future payment of assets or services that a company is presently obligated to make as a result of past transactions or events. Present obligation to make a future payment. Result from past transactions. May be classified as current or long-term. SAP 2007 / SAP University Alliances Introductory Accounting

Current vs. Long-Term Liabilities Current Liabilities • Are due within one year or within the next operating cycle, whichever is longer. • Are settled using current assets or by creating other current liabilities. Long-Term Liabilities • Do not require payment within the longer of one year or an operating cycle. SAP 2007 / SAP University Alliances Introductory Accounting

Current vs. Long-Term Liabilities Current liability Balance sheet date Long-term liability 1 year or operating cycle Examples: • Accounts payable • Unearned revenues • Wages payable • Current portion of notes payable SAP 2007 / SAP University Alliances • Bonds payable • Lease obligations • Long-term portion of notes payable Introductory Accounting

Known (Determinable) Liabilities Are obligations that have little uncertainty and are set by agreements, contracts, or laws. Examples: • Accounts payable • Unearned revenues • Payroll taxes • Sales taxes • Notes payable SAP 2007 / SAP University Alliances Introductory Accounting

Short-Term Notes Payable A current obligation in the form of a written promissory note. • May be issued: • To replace an account payable • When obtaining a bank loan • To purchase merchandise or other assets SAP 2007 / SAP University Alliances Introductory Accounting

Short-Term Notes Payable: Example On November 30, a note is used to replace a $5, 000 overdue account payable that does not bear interest. The customer agrees to pay $1, 000 cash and sign a 60 -day, 10% note to replace the account payable. The customer’s entry to record this transaction would be: Accounts payable Cash Notes payable SAP 2007 / SAP University Alliances 5, 000 1, 000 4, 000 Introductory Accounting

On December 31, the customer’s year end, an interest accrual is made. The customer’s entry to record this accrual would be: Interest expense 33. 97 Interest payable 33. 97 $4, 000 x 10% x 31/365 SAP 2007 / SAP University Alliances Introductory Accounting

On January 30, the note’s due date, the note and interest is paid in full. The customer’s entry to record this would be: Notes payable Interest expense Cash 4, 000. 00 33. 97 31. 78 4, 065. 75 $4, 000 x 10% x 29/365 = $37. 78 SAP 2007 / SAP University Alliances Introductory Accounting