Receivables

1. Receivables Chapter 8

2. 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

3. Accounts Receivable • Amounts to be collected from customers for sales on credit • Serves as a control account • Control account –account that summarizes related subsidiary accounts. • Customer ledger • Subsidiary ledger showing each customer’s balance

5. Notes Receivable • More formal than accounts receivable • Usually longer in term • Debtor promises to pay by maturity date • Maturity date–date the debt must be completely paid off • Current assets if due within one year or less • Long-term assets if due beyond one year • Promissory note • Written document signed by both parties

6. Internal Controls and Receivables • Credit department evaluates customers’ applications • Separation of duties • Credit department should not handle cash • Cash handlers should not extend credit

7. S8-1: Different types of receivables What is the difference between accounts receivable and notes receivable? Notes receivable include a charge for interest; accounts receivable do not. Accounts receivable are current assets; notes receivable are current or long-term assets. Notes receivable are more formal than accounts receivable. Notes receivable are evidenced by the debtor signing a promissory note; accounts receivable are not.

8. 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

9. Accounting for Uncollectibles (Bad Debts) • Starts with selling on account • Collecting cash is the second step

11. Allowance Method • Based on the matching principle • Record uncollectible accounts expense in same period as sales • Expense is estimated from past experience • Offset to expense is the allowance for uncollectible accounts • A contra asset, contra to accounts receivable • Reduces account receivables to a net receivable

12. Estimating Uncollectibles • Companies use their history, the economy and industry information to estimate uncollectibles • Percent-of-sales • Income-statement approach • Estimates uncollectible accounts as a percent of sales • Aging-of-accounts • Balance-sheet approach • Determine target allowance based on age of actual receivables

13. 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

14. S8-3 : Applying the allowance method (percent-of-sales) to account for uncollectibles 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.

15. S8-3: Applying the allowance method (percent-of-sales) to account for uncollectibles • Journalize Spring’s sales and uncollectible account expense using the percent-of sales method.

16. S8-3: Applying the allowance method (percent-of- sales) to account for uncollectibles 2. Show how to report accounts receivable on the balance sheet at December 31, 2012. Use the long reporting format illustrated in the chapter.

17. Aging Method • Focuses on actual age of the accounts receivable • Determines a target allowance balance AR Total Expected not to collect

18. Aging Method • The amount not expected to be collected becomes the allowance account target balance

19. Aging Method • Journal entry • $150 credit balance plus/minus adjustment = $400 250 $400

20. S8-5: Applying the allowance method (aging-of-accounts) to account for uncollectibles Summer and Sandcastles Resort had the following balances at December 31, 2012, before the year-end adjustments: The aging of accounts receivable yields the following data: Accounts receivable Allowance for uncollectible accounts 78,000 Beg Bal 1,900

21. S8-5 : Applying the allowance method (aging-of-accounts) to account for uncollectibles • Journalize Summer’s entry to adjust the allowance account to its correct balance at December 31, 2012. • Prepare a T-account to compute the ending balance of Allowance for uncollectible accounts. Accounts receivable Allowance for uncollectible accounts 78,000 Beg Bal 1,900 Adj 1,820 _ __________________________________________ End Bal 3,720

22. Writing off Uncollectible Accounts • When a specific customer account is identified as uncollectible, it is written off to the allowance account

23. 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. Summary of Entries • Make sales on account • Establish a pool for future potential uncollectibility(?%) • Collect cash on account • Identify a bad debt • Adjust allowance account to reflect adjustments to the estimate • Recover previously written off account

25. Direct Write-Off Method • Used by small businesses • No Allowance for uncollectible accounts • Records uncollectible accounts expense when specific account is written off

26. Problems with Direct Write-Off Method • Overstates Accounts receivable on the balance sheet • No Allowance account • Violates matching principle • Uncollectible account expense often not in same period as sale • Not GAAP

27. 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

28. Credit Card Sales • Credit-card sales are an alternative form for receiving payments • Two types: • Issued by a financial institution • Visa • Mastercard • Issued by a credit card company • American Express • Discover

29. Debit Cards • Different than credit and bankcards • Same as cash • Amount subtracted from buyer’s bank account • Amount added to retailer’s bank account

30. Bank Cards • Retailers receive cash at time of sale • Visa and MasterCard 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

31. S8-8 : Recording credit-card and debit-card sales 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 ValueCard 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.

32. S8-8 : Recording credit-card and debit-card sales National Express credit-card sales . . . . . $ 9,300 ValueCard debit-card sales . . . . . . . . . . . 9,000

33. 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

34. Notes Receivable Key Terms

35. Identifying Maturity Date • Maturity date can be: • A specific date, such as March 13 • Stated in terms of number of months • A six-month note dated February 16, 2014, would mature on August 16, 2014 • Stated in terms of number of days • Must count days from issue date to maturity day

36. Computing Interest • By the year • By the month • By the day 360 days used in this example to simplify calculations

37. 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

38. Accruing Interest Timeline • On the maturity date

39. Loan Out Money

40. Sell Merchandise in Exchange for Notes Receivable

41. Converting Accounts Receivable toNotes Receivable • A company may accept a note receivable from a customer who fails to pay an account receivable

42. S8-10 : Accounting for a note receivable 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): • Lending the money on June 6. • Collecting the principal and interest at maturity. Specify the date. For the computation of interest, use a 360-day year.

43. S8-10 : Accounting for a note receivable Lending the money on June 6. Collecting the principal and interest at maturity. Specify the date. For the computation of interest, use a 360-day year.

44. Dishonored Notes Receivable • Maker of note does not pay • Move the note receivable into accounts receivable • Interest is added to the new accounts receivable

45. Accounts Receivable on the Balance Sheet • Current asset, shown net of allowances • Two presentation styles:

47. Eastman Footnote Disclosure

48. Acid-Test Ratio • Also called the “quick ratio” • Stringent measure of liquidity • Measures entity’s ability to pay its current liabilities immediately

50. 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