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Chapter 7

Chapter 7. Accounts and Notes Receivable. Conceptual Learning Objectives. Self-Study: C1: Describe accounts receivable and how they occur and are recorded. C2: Describe a note receivable and the computation of its maturity date and interest.

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Chapter 7

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  1. Chapter 7 Accounts and Notes Receivable

  2. Conceptual Learning Objectives Self-Study: C1: Describe accounts receivable and how they occur and are recorded. C2: Describe a note receivable and the computation of its maturity date and interest. C3: Explain how receivables can be converted to cash before maturity. 7-2

  3. Analytical Learning Objectives A1: Compute accounts receivable turnover and use it to help assess financial condition. 7-3

  4. Procedural Learning Objectives P1: Apply the direct write-off and allowance methods to account for accounts receivable. P2: Estimate uncollectibles using methods based on sales and accounts receivable. P3: Record the receipt of a note receivable. P4: Record the honoring and dishonoring of a note and adjustments for interest. 7-4

  5. Accounts Receivable C 1 Amounts due from customers for credit sales (2/10, n/30). • Credit sales require: • Maintaining a separate account receivable for each customer. • Accounting for bad debts that result from credit sales. 7-5

  6. $4.3 Mil. $9.392 Mil. $118 Mil. $109 Mil. Percentage of total assets Recognizing Accounts Receivable C 1 7-6

  7. Accounts Receivable Sales on Credit => A/RCredit sales are recorded by increasing (debiting) Accounts Receivable. a. The General Ledger Account continues to keep a single Accounts Receivable account. b. A supplementary record, called the accountsreceivable ledger account, is created to maintain a separate account for each customer. c. The sum of the individual (subsidiary) accounts in the accounts receivable ledger equals the debit balance of the Accounts Receivable account in the general ledger (Master Account).

  8. Sales on Credit C 1 On July 16, Barton, Co. sells $950 of merchandise on credit to Webster, Co., and $1,000 of merchandise on account to Matrix, Inc. 7-8

  9. Sales on Credit C 1 7-9

  10. Sales on Credit C 1 On July 31, Barton, Co. collects $500 from Webster, Co., and $800 from Matrix, Inc. on account. 7-10

  11. Sales on Credit C 1 7-11

  12. Exercise 2

  13. Credit Card Sales C 1 Advantages of allowing customers to use credit cards: Customers’ credit is evaluated by the credit card issuer. Sales increase by providing purchase options to the customer. Cash collections are quicker. The risks of extending credit are transferred to the credit card issuer. 7-13

  14. Credit Card Sales C 1 • With bank credit cards, the seller deposits the credit card sales receipt in the bank just like it deposits a customer’s check. • The bank increases the balance in the company’s checking account. • The company usually pays a fee of 1% to 5% for the service. 7-14

  15. Credit Card Sales(Immediate receipt of cash) C 1 On July 16, 2009, Barton, Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 2%. The cash is received immediately. 7-15

  16. Credit Card Sales (Delayed receipt of Cash) On July 16, 2009, Barton, Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 1%. Barton remits the credit card sale to the credit card company and waits for the payment that is received on July 28. 7-16

  17. Quick Study 1 Exercise 1

  18. Installment Accounts Receivable C 1 Amounts owed by customers from credit sales for which payment is required in periodic amounts over an extended time period. The customer is usually charged interest. 7-18

  19. The Matching Principle requires expenses to be reported in the same accounting period as the sales they help to produce.

  20. Valuing Accounts Receivable P1 Some customers may not pay their account. -Uncollectible amounts are referred to as bad debts. -There are two methods of accounting for bad debts: • Direct Write-Off Method (Violates MATCHING) • Allowance Method (Based on MATCHING)- % of Sales method => I/S Approach- % of Receivables method => B/S Approach 7-20

  21. Direct Write-Off Method The direct write-off method:Records the loss from an uncollectible account receivable when it is determined to be uncollectible. ||Violates MATCHING Principle • Entry to write off uncollectible and recognize loss: Debit: Bad Debt Expense Credit: Accounts Receivable. • b. If a written off account is later collected, this results in a reversal of the write off (see a.) and a normal collection of account entry.

  22. Direct Write-Off Method On August 4th, 2009, Barton determines it cannot collect $350 from Martin, Inc., a credit customer.Note: Sales to Martin occurred on November 10th, 2008. 7-22

  23. Direct Write-Off Method On September 9th, 2010, Martin decides to pay $200 that was previously written off. If a written off account is later collected, this results in a reversal of the write off (see Aug. 4th, 2009 entry) and a normal collection of account entry. 7-23

  24. Matching vs. Materiality P1 The Matching Principle requires expenses to be reported in the same accounting period as the sales they help to produce. The Materiality Constraint states that an amount can be ignored if its effect on the financial statements is unimportantto users’ business decisions. 7-24

  25. Matching vs. Materiality Under the matching principle, the direct write-off method usually does not best match sales and expenses. But, the materiality constraint permits the use of the direct write-off method when bad debts expenses are very small in relation to a company’s other financial statement items.

  26. Allowance Method At the end of each period, estimatetotal bad debts expected to be realized from That period’s sales. There are two advantages to the allowance method: 1. It records estimated bad debts expense in the period when the related sales are recorded. => Proper matching of Expenses with Income on I/S; • It reports accounts receivable on the balance sheet at the estimated amount (Realizable value) of cash to be collected. => Proper VALUATION of A/R on Balance Sheet. 7-26

  27. Contra-asset account Recording Bad Debts Expense At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2009, is $278,000. 7-27

  28. Recording Bad Debts Expense At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2009, is $278,000. 7-28

  29. Allowance Method of estimating Bad Debts Expenses Two Methods • Percent of Sales Method 2. Accounts Receivable Methods • Percent of Accounts Receivable Method • Aging of Accounts Receivable Method 7-29

  30. Percent of Sales Method Bad debts expense is computed as follows: Barton has credit sales of $1,400,000 in 2009. Management estimates 0.5% of credit sales will eventually prove uncollectible. What is Barton’s Bad Debts Expense for 2009? 7-30

  31. Percent of Sales Method P2 Barton’s accountant computes estimated Bad Debts Expense of $7,000. 7-31

  32. Percent of Sales Method Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on Dec.31, 2009. What is the balance in AFDA on Dec. 31, 2009? Prepare the ‘T’ accounts for A/R and AFDA showing the balances as of 12/31/09.

  33. Percent of Sales Method Quick Study 4; Exercise 4: -% of Sales;-Partial B/S Exercise 9a: -% of Sales; -Partial B/S.Exercise 9b: -% of Sales; -Partial B/S

  34. Percent of Accounts Receivable Method • Compute the estimate of the Allowance for Doubtful Accounts: • Bad Debts Expense is computed as: 7-34

  35. Percent of Accounts Receivable Barton has$100,000 in accounts receivableand a$900 credit balance in Allowance for Doubtful Accountson December 31, 2009. Past experience suggests that 4% of receivables are uncollectible. What is Barton’s Bad Debts Expense for 2009? What is the balance in AFDA on Dec. 31, 2009? 7-35

  36. Desired balance in Allowance for Doubtful Accounts. Percent of Accounts Receivable 7-36

  37. Percent of Accounts Receivable

  38. Percent of Accounts Receivable Quick Study 3; Exercise 5: -% of A/R; -Partial B/S;Exercise 7: -% of A/R; -Partial B/S; Exercise 9c:-% of A/R; -Partial B/S.

  39. Aging of Accounts Receivable Method • Each receivable is grouped by how long it is past its due date. • Each age group is multiplied by its estimated bad debts percentage. • Estimated bad debts for each group are totaled. 7-39

  40. Aging of Accounts Receivable P2 7-40

  41. Aging of Accounts Receivable P2 Barton’s unadjusted balance in the allowance account is $900. We estimated the proper balance to be $5,320. 7-41

  42. Aging of Accounts Receivable Exercise 6: a, b & c

  43. Writing Off a Bad Debt under the Allowance Method With the allowance method, when an account is determined to be uncollectible, the debit goes to Allowance for Doubtful Accounts. Barton determines that Martin’s $300 account is uncollectible. 7-43

  44. Recovery of a Bad Debt P2 Subsequent collections on accounts written off require that the original write-off entry be reversed before the cash collection is recorded. 7-44

  45. Exercise 6 & 8

  46. % of Sales % of Receivables Aging of Receivables Emphasis on Matching Emphasis on Realizable Value Emphasis on Realizable Value Sales Accts. Rec. Accts. Rec. Bad Debts Exp. All. for Doubtful Accts. All. for Doubtful Accts. Summary P2 Income Statement Focus Balance Sheet Focus Balance Sheet Focus 7-46

  47. Term Payee Principal Interest Rate Maker Due Date Notes Receivable P3 $1,000.00 July 10, 2009 Ninety days after date I promise to pay to Barton Company, Los Angeles, CA the order of One thousand and no/100 --------------------------------- Dollars First National Bank of Los Angeles, CA Payable at 12% Value received with interest at per annum Julia Browne 42 Oct. 8, 2009 No. Due 7-47

  48. Even for maturities less than one year, the rate is annualized. If the note is expressed in days, base a year on 360 days. Interest Computation P3 7-48

  49. Computing Maturity and Interest P3 On March 1, 2009, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier. What is the maturity date of the note? 7-49

  50. Computing Maturity and Interest P3 The note is due and payable on May 30, 2009. How much interest will Matrix pay to Office Supplies, Inc. on this note? 7-50

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