Accounts Receivable

Accounts Receivable Generally, two major issues: • How to Record Sales Discounts

Accounts Receivable Generally, two major issues: • How to Record Sales Discounts • How to Record Doubtful Receipts

Accounts Receivable Discounts The most prevalent is the cash discount for early payment on the account.

Accounts Receivable Discounts The most prevalent is the cash discount for early payment on the account. Example: 2/10, n/30

Accounts Receivable Discounts The most prevalent is the cash discount for early payment on the account. Example: 2/10, n/30 2% discount if paid within 10 days

Accounts Receivable Discounts The most prevalent is the cash discount for early payment on the account. Example: 2/10, n/30 Net amount due in 30 days.

Accounts Receivable Discounts Two methods to record the discount: • Gross Method: record primary sale at gross amount

Accounts Receivable Discounts Two methods to record the discount: • Gross Method: record primary sale at gross amount Usually for firms whose clients generally don’t take advantage of the discounts

Accounts Receivable Discounts Two methods to record the discount: • Gross Method: record primary sale at gross amount • Net Method: record primary sale at net-of-discount amount

Accounts Receivable Discounts Two methods to record the discount: • Gross Method: record primary sale at gross amount • Net Method: record primary sale at net-of-discount amount Usually for firms whose clients generally take advantage of the discounts

Accounts Receivable Discounts Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms.

Accounts Receivable Discounts Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms. Gross Method Jan 1 Accts Rec 10,000 Sales 10,000

Accounts Receivable Discounts Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms. Gross Method Jan 1 Accts Rec 10,000 Sales 10,000 Recorded as if discount won’t be taken

Accounts Receivable Discounts Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms. Gross Method Jan 1 Accts Rec 10,000 Sales 10,000 Net Method Jan 1 Accts Rec 9,800 Sales 9,800

Accounts Receivable Discounts Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms. Gross Method Jan 1 Accts Rec 10,000 Sales 10,000 Net Method Jan 1 Accts Rec 9,800 Sales 9,800 Recorded as if discount will be taken

Accounts Receivable Discounts Example: Jan 9th, receive payment within discount period

Accounts Receivable Discounts Example: Jan 9th, receive payment within discount period Gross Method Jan 9 Cash 9,800 Sales Discs 200 Accts Rec 10,000

Accounts Receivable Discounts Example: Jan 9th, receive payment within discount period Gross Method Jan 9 Cash 9,800 Sales Discs200 Accts Rec 10,000 If the discount is actually realized, it is recorded upon receipt of the cash payment. Sales Discounts is a contra-revenue account.

Accounts Receivable Discounts Example: Jan 9th, receive payment within discount period Gross Method Jan 9 Cash 9,800 Sales Discs 200 Accts Rec 10,000 Net Method Jan 9 Cash 9,800 Accts Rec 9,800

Accounts Receivable Discounts Example: Jan 9th, receive payment within discount period Gross Method Jan 9 Cash 9,800 Sales Discs 200 Accts Rec 10,000 Net Method Jan 9 Cash 9,800 Accts Rec 9,800 Discount has already been recorded on sales date.

Accounts Receivable Discounts Example: Jan 29th, receive payment outside discount period Now assume instead that the payment was sent after the discount period expired.

Accounts Receivable Discounts Example: Jan 29th, receive payment outside discount period Gross Method Jan 29 Cash 10,000 Accts Rec 10,000

Accounts Receivable Discounts Example: Jan 29th, receive payment outside discount period Gross Method Jan 29 Cash 10,000 Accts Rec 10,000 No correction needed, since we already assumed the discount would not be taken.

Accounts Receivable Discounts Example: Jan 29th, receive payment outside discount period Gross Method Jan 29 Cash 10,000 Accts Rec 10,000 Net Method Jan 29 Cash 10,000 Accts Rec 9,800 Forfeited Discount 200

Accounts Receivable Discounts Example: Jan 29th, receive payment outside discount period Gross Method Jan 29 Cash 10,000 Accts Rec 10,000 Net Method Jan 29 Cash 10,000 Accts Rec 9,800 Forfeited Discount 200 Record the forfeited discount (a revenue account).

Accounts Receivable Doubtful Receipts All receivables have some probability of default. The default on payment needs to be recorded appropriately.

Accounts Receivable Doubtful Receipts One method of recording default is to record a loss when actual default occurs. This is called the direct write-off method.

Accounts Receivable Doubtful Receipts One method of recording default is to record a loss when actual default occurs. This is called the direct write-off method. Not considered an acceptable method because it does not match revenues with costs effectively.

Accounts Receivable Doubtful Receipts The accepted method is called the Allowance Method.

Accounts Receivable Doubtful Receipts The accepted method is called the Allowance Method. An Allowance for Doubtful Accounts is set up as a contra-receivable account (contra-asset). It holds management’s best estimate for the amount of receivables that will default.

Accounts Receivable Doubtful Receipts To determine management’s best estimate for default, use one of two methods:

Accounts Receivable Doubtful Receipts To determine management’s best estimate for default, use one of two methods: • Percentage of Sales Method: a fixed percentage • of sales will be considered doubtful

Accounts Receivable Doubtful Receipts To determine management’s best estimate for default, use one of two methods: • Percentage of Sales Method: a fixed percentage • of sales will be considered doubtful This is also called the income statement approach, since the estimate is based on a percentage of sales revenue.

Accounts Receivable Doubtful Receipts To determine management’s best estimate for default, use one of two methods: • Percentage of Sales Method: a fixed percentage • of sales will be considered doubtful • Percentage of Receivables Method: a fixed • percentage of the receivables balance will be • considered doubtful

Accounts Receivable Doubtful Receipts To determine management’s best estimate for default, use one of two methods: • Percentage of Sales Method: a fixed percentage • of sales will be considered doubtful • Percentage of Receivables Method: a fixed • percentage of the receivables balance will be • considered doubtful This is also called the balance sheet approach, since the estimate is based on a percentage of a balance sheet receivable account.

Accounts Receivable Doubtful Receipts Example: Assume Paterno Corp. has $200,000 in sales during 2000. Of these sales, 30% are in cash and 70% are on credit. They estimate that 4% of their credit sales will not be collected.

Accounts Receivable Doubtful Receipts Example: Assume Paterno Corp. has $200,000 in sales during 2000. Of these sales, 30% are in cash and 70% are on credit. They estimate that 4% of their credit sales will not be collected. 2000 Credit Sales: 0.70 x $200,000 = $140,000

Accounts Receivable Doubtful Receipts Example: Assume Paterno Corp. has $200,000 in sales during 2000. Of these sales, 30% are in cash and 70% are on credit. They estimate that 4% of their credit sales will not be collected. 2000 Credit Sales: 0.70 x $200,000 = $140,000 Estimate of doubtful collections: 0.04 x $140,000 = $5,600

Accounts Receivable Doubtful Receipts Example: Assume Paterno Corp. has $200,000 in sales during 2000. Of these sales, 30% are in cash and 70% are on credit. They estimate that 4% of their credit sales will not be collected. Journal entry (percentage of sales): Bad Debt Expense $5,600 Allowance for Doubtful Accts $5,600

Accounts Receivable Doubtful Receipts Now assume that Paterno Corp. has $300,000 in Accounts Receivable prior to this year’s credit sales. The firm estimates that 6% of the A/R balance is not collectible.

Accounts Receivable Doubtful Receipts Now assume that Paterno Corp. has $300,000 in Accounts Receivable prior to this year’s credit sales. The firm estimates that 6% of the A/R balance is not collectible. Accts Receivable Beg. Bal. $300,000 Allow. for doubtful Accts. Beg. Bal $18,000

Accounts Receivable Doubtful Receipts Now assume that Paterno Corp. has $300,000 in Accounts Receivable prior to this year’s credit sales. The firm estimates that 6% of the A/R balance is not collectible. Accts Receivable Beg. Bal. $300,000 Allow. for doubtful Accts. Beg. Bal $18,000 Accts Receivable End. Bal $440,000

Accounts Receivable Doubtful Receipts Now assume that Paterno Corp. has $300,000 in Accounts Receivable prior to this year’s credit sales. The firm estimates that 6% of the A/R balance is not collectible. Accts Receivable Beg. Bal. $300,000 Allow. for doubtful Accts. Beg. Bal $18,000 Accts Receivable End. Bal $440,000 $300,000 + $140,000 (70% of sales)

Accounts Receivable Doubtful Receipts Now assume that Paterno Corp. has $300,000 in Accounts Receivable prior to this year’s credit sales. The firm estimates that 6% of the A/R balance is not collectible. Accts Receivable Beg. Bal. $300,000 Allow. for doubtful Accts. Beg. Bal $18,000 Accts Receivable End. Bal $440,000 Required AFDA End. Bal $26,400 $440,000 x 6%

Accounts Receivable Doubtful Receipts Now assume that Paterno Corp. has $300,000 in Accounts Receivable prior to this year’s credit sales. The firm estimates that 6% of the A/R balance is not collectible. Accts Receivable Beg. Bal. $300,000 Allow. for doubtful Accts. Beg. Bal $18,000 Accts Receivable End. Bal $440,000 Required AFDA End. Bal $26,400 Required Entry to Adjust Allowance for doubtful accounts (percentage of receivables method): Bad Debt Expense $8,400 Allowance for Doubtful Accts $8,400

Accounts Receivable Doubtful Receipts Now assume that Paterno Corp. has $300,000 in Accounts Receivable prior to this year’s credit sales. The firm estimates that 6% of the A/R balance is not collectible. Accts Receivable Beg. Bal. $300,000 Allow. for doubtful Accts. Beg. Bal $18,000 Accts Receivable End. Bal $440,000 Required AFDA End. Bal $26,400 Required Entry to Adjust Allowance for doubtful accounts (percentage of receivables method): Bad Debt Expense $8,400 Allowance for Doubtful Accts $8,400 Need to add $8,400 to beginning balance to meet required ending balance.

Accounts Receivable Sales Returns and Allowances Returns and allowances are handled in the same manner as doubtful collection. An account called Allowance for Sales Returns is set up based on management’s best estimate for returns.

Notes Receivable • A written promise to pay • Usually longer-term and more formal • Usually for a stated amount and a specified period • Either formally stated or implicit interest rate

Notes Receivable • A written promise to pay • Usually longer-term and more formal • Usually for a stated amount and a specified period • Either formally stated or implicit interest rate Implicit interest is when there is no formally stated interest rate, but the note is priced at a discount.

Notes Receivable • A written promise to pay • Usually longer-term and more formal • Usually for a stated amount and a specified period • Either formally stated or implicit interest rate Implicit interest is when there is no formally stated interest rate, but the note is priced at a discount. For example, a $1,000, 1-year note (with no stated interest rate) that sells for $900 has an implied interest rate of 11.1%.

Accounts Receivable