Receivables Chapter 8 1 Copyright 2012 Pearson Education

Learning Objectives Define and explain common types of receivables and review internal controls for receivables Use the allowance method to account for uncollectibles Understand the direct write-off method for uncollectibles Journalize credit-card and debit-card sales 2 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Learning Objectives Account for notes receivable Report receivables on the balance sheet and evaluate a company using the acid-test ratio, days’ sales in receivables, and the accounts receivable turnover ratio Discount a note receivable (see Appendix 8 A) 3 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

1 Define and explain common types of receivables and review internal controls for receivables

Receivables Selling goods or services to another party on credit Right to receive cash in the future from a current transaction Two types: Accounts receivable Notes receivable An asset 5 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accounts Receivable Amounts to be collected from customers for sales on credit Serves as

Notes Receivable More formal than accounts receivable Usually longer in term Current assets if due within one year or less Long-term assets if due beyond one year Promissory note 7 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Internal Controls and Receivables Credit department evaluates customers’ applications Separation of duties 8 Copyright

What is the difference between accounts receivable and notes receivable? 9 Copyright © 2012

2 Use the allowance method to account for uncollectibles 10 Copyright © 2012 Pearson

Accounting for Uncollectibles (Bad Debts) Selling on credit: BENEFIT–Increase sales by selling to a wider range of customers COST–Some customers don’t pay Results in uncollectible account expense Two methods to account for uncollectible accounts: Allowance method Direct write-off method 11 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accounting for Uncollectibles (Bad Debts) Starts with selling on account Collecting cash is the

Allowance Method Based on the matching principle Offset to expense is the allowance for

Estimating Uncollectibles Companies use their history, the economy and industry information to estimate uncollectibles Percent-of-sales Aging-of-accounts 14 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Percent-of-Sales Method Begins with account balances Beginning balance below Compute the estimate and journalize it Net realizable value is the expected amount to collect 15 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

During its first year of operations, Spring Garden Plans earned revenue of $322, 000 on account. Industry experience suggests that bad debts will amount to 2% of revenues. At December 31, 2012, accounts receivable total $36, 000. The company uses the allowance method to account for uncollectibles. 16 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

1. Journalize Spring’s sales and uncollectible account expense using the percent-of sales method. DATE 17 Journal Entry ACCOUNTS AND EXPLANATIONS DEBIT CREDIT Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

2. Show to report accounts receivable on the balance sheet at December 31, 2012. Use the long reporting format illustrated in the chapter. 18 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Aging Method Focuses on actual age of the accounts receivable Determines a target allowance

Aging Method The amount not expected to be collected becomes the allowance account target balance Journal entry $150 credit balance plus/minus adjustment = $400 20 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Summer and Sandcastles Resort had the following balances at December 31, 2012, before the year-end adjustments: Accounts receivable Allowance for uncollectible accounts The aging of accounts receivable yields the following data: Age of Accounts Receivable 0 -60 days Over 60 Days Total Receivables $3, 000 + $720 = $ 3, 720 Amount receivable % uncollectible Amount uncollectible 21 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

1. Journalize Summer’s entry to adjust the allowance account to its correct balance at December 31, 2012. DATE Journal Entry ACCOUNTS AND EXPLANATIONS DEBIT CREDIT 2. Prepare a T-account to compute the ending balance of Allowance for uncollectible accounts. Accounts receivable Allowance for uncollectible accounts 22 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Writing off Uncollectible Accounts When a specific customer account is identified as uncollectible, it is written off to the allowance account 23 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Recovery of Account Sometimes a customer will pay the amount owed after the customer’s account is written off Two entries needed: Reverse the uncollectable account Record the payment 24 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Summary of Entries Make sales on account Establish a pool for future potential uncollectibility (2%) Collect cash on account Identify a bad debt Adjust allowance account to reflect adjustments to the estimate Recover previously written off account 25 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Summary of Entries 26 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

3 Understand the direct write-off method for uncollectibles 27 Copyright © 2012 Pearson Education,

Direct Write-Off Method Used by small businesses No Allowance for uncollectible accounts Records uncollectible accounts expense when specific account is written off 28 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Problems with Direct Write-Off Method Overstates Accounts receivable on the balance sheet Violates matching

Direct Write-Off Recovery of Debt Direct write-off of debt recovery process is different from the allowance method The debt was written off the books To recover: Reverse the write-off journal entry Record the cash payment 30 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Gate City Cycles had trouble collecting its account receivable from Sue Ann Noel. On June 19, 2012, Gate City finally wrote off Noel’s $700 account receivable. Gate City turned the account over to an attorney, who hounded Noel for the rest of the year. On December 31, Noel sent a $700 check to Gate City Cycles with a note that said, “Here’s your money. Please call off your bloodhound!” 1. Journalize the entries required for Gate City Cycles, assuming Gate City uses the direct write-off method. 31 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Journal Entry DATE Jun ACCOUNTS AND EXPLANATIONS DEBIT CREDIT 19 Dec 31 32 Copyright

4 Journalize credit-card and debit-card sales 33 Copyright © 2012 Pearson Education, Inc. Publishing

Credit Card Sales Credit-card sales are an alternative form for receiving payments Two types: Issued by a financial institution Issued by a credit card company 34 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Debit Cards Different than credit and bankcards Same as cash Amount subtracted from buyer’s bank account Amount added to retailer’s bank account 35 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Bank Cards Retailers receive cash at time of sale Visa and Master. Card most common bank cards Retailer accepting the credit cards pays a fee Two types of fee transactions: NET: The total sale less the processing fee assessed equals the net amount of cash deposited Gross: The total sale is deposited and the fee is deducted at the end of the month Journal entry similar to cash sales 36 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Restaurants do a large volume of business by credit and debit cards. Suppose Chocolate Passion restaurant had these transactions on January 28, 2012: National Express credit-card sales. . . $ 9, 300 Value. Card debit-card sales. . . 9, 000 Suppose Chocolate Passion’s processor charges a 3% fee and deposits sales net of the fee. Requirement: 1. Journalize these sale transactions for the restaurant. 37 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

National Express credit-card sales. . . $ 9, 300 Value. Card debit-card sales. . . 9, 000 Journal Entry DATE Jan 28 ACCOUNTS AND EXPLANATIONS POST. REF. DEBIT CREDIT 28 38 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

5 Account for notes receivable 39 Copyright © 2012 Pearson Education, Inc. Publishing as

Notes Receivable More formal than Accounts receivable Debtor signs promissory note A written promise to pay a specified amount of money at a particular future date 40 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Notes Receivable Key Terms 41 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice

Identifying Maturity Date Maturity date can be: A specific date, such as March 13 Stated in terms of number of months Stated in terms of number of days 42 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Determine the Maturity Date A 180 -day note dated February 16, 2014 matures on

Computing Interest By the year By the month By the day 44 Copyright ©

Accruing Interest Revenue If notes receivable are outstanding, interest must be accrued Interest is earned over time Revenue must be recorded in the period earned 45 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accruing Interest Timeline On the maturity date 46 Copyright © 2012 Pearson Education, Inc.

Loan Out Money 47 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Sell Merchandise in Exchange for Notes Receivable 48 Copyright © 2012 Pearson Education, Inc.

Converting Accounts Receivable to Notes Receivable A company may accept a note receivable from a customer who fails to pay an account receivable 49 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Lakeland Bank & Trust Company lent $110, 000 to Samantha Michael on a 90 -day, 9% note. 1. Journalize the following transactions for the bank (explanations are not required): a. Lending the money on June 6. b. Collecting the principal and interest at maturity. Specify the date. For the computation of interest, use a 360 -day year. 50 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

a. Lending the money on June 6. b. Collecting the principal and interest at maturity. Specify the date. For the computation of interest, use a 360 -day year. Journal Entry DATE ACCOUNTS AND EXPLANATIONS Jun 6 Sept 6 Cash Note receivable—S. Michael Interest revenue ($110, 000 ×. 09 × 90/360) 51 POST. DEBIT CREDIT REF. 112, 475 110, 000 2, 475 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Dishonored Notes Receivable Maker of note does not pay Move the note receivable into accounts receivable Interest is added to the new accounts receivable 52 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Computers and Receivables Accounts receivable can be computerized allowing the order entry, shipping, and billing departments to work together 53 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

6 Report receivables on the balance sheet and evaluate a company using the acid-test ratio, days’ sales in receivables, and the accounts receivable turnover ratio 54 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accounts Receivable on the Balance Sheet Current asset, shown net of allowances Two presentation

Acid-Test Ratio Also called the “quick ratio” Stringent measure of liquidity Measures entity’s ability to pay its current liabilities immediately 56 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Days’ Sales in Receivables Also called “collection period” It is number of days it takes to collect the average balance of receivables The shorter the collection period, the more quickly cash is available Two step process: Find one day’s sales Find day’s sales in receivables 57 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Days’ Sales in Receivables Step 1: One day’s sales is calculated Net sales (Total

Days’ Sales in Receivables Step 2: Day’s sales in inventory Average net receivables divided

Accounts Receivable Turnover Ratio Measures the number of times the company sells and collects the average receivables Higher the ratio, the faster the cash collections occur Benchmark on how well a company is managing its receivables 60 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Northend Medical Center included the following items in its financial statements: 1. How much net income did Northend earn for the month? Service revenue. . . ………… Less: Cost of services sold and other expenses… Net income. . . . . ………………… 61 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

2. Show two ways Northend can report receivables on its classified balance sheet: Current assets: Accounts receivable. . . . …………. . . Less: Allowance for doubtful accounts. . . Accounts receivable, net. . . . …. . . or Accounts receivable, net of allowance 62 for uncollectible accounts of $150…………. . . Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Southside Clothiers reported the following items at September 30, 2012 (last year’s— 2011—amounts also given as needed): Compute Southside’s (a) acid-test ratio, (b) days’ sales in average receivables for 2012, and (c) accounts receivable turnover ratio. Evaluate each ratio value as strong or weak. Southside sells on terms of net 30. 63 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

(a) Acid-test ratio = Cash + Short-term investments + Net current receivables Total

(b) Days’ sales in average receivables = * Average net accounts receivable ** One day’s sales = *Average net accounts receivable= **One day’s sale=(Net sales/365 days) = $ = 65 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

(c) Accounts receivable = Turnover Ratio Net sales revenue Average net accounts receivable

7 Discount a note receivable (see Appendix 8 A) 67 Copyright © 2012 Pearson

Discount a Note Receivable The payee needs cash before the maturity date Payee sells the receivables Amount is determined by present-value concepts 68 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Steps in Discounting a Note Receivable Compute the original amount of interest on the note receivable Maturity value of the note = Principal + Interest Determine the period (number of days, months, or years) the bank will hold the note (the discount period) Compute the bank’s discount on the note This is the bank’s interest revenue from holding the note Seller’s proceeds from discounting the note receivable = Maturity value of the note – Bank’s discount on the note 69 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Example of Discounting a Note $1, 000 note is received on September 30, 2015 Maturity date is one year Note is discounted on November 30, 2014 Interest applied is 12%, and is higher than notes Amounts received is called proceeds 70 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Example of Discounting a Note If proceeds are less than principle amount, the payee debits Interest expense If proceeds are greater than principle amount, the payee debits Interest revenue 71 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

72 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. 73 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.