Receivables

1. 201Lec08.PPTX 8 Receivables Amounts due from individuals and other companies that are expected to be collected in cash. Trade Receivables are owed by customers that result from the sale of goods and services. A/R are not supported by a formal document. “Nontrade” (interest, loans to employees or officers, income tax refunds, etc). Accounts Receivable Notes Receivable Other Receivables 1

2. Issues regarding receivables addressed by GAAP: • Balance sheet: What amount should be used? • Income statement:When should bad debt expense be recorded? • Example: Assume Chuck Co. has: • $1,000,000 of sales in December 2013, its first year. • All are on credit, terms net 90 days. • Gross profit is 40%, operating expenses are $30,000. • Now assume that half of all A/R are uncollectible due to poor credit screening and customer bankruptcies. 2

3. Optionsfor 2013 Balance Sheet and Income Statement: Direct Method A/R 1,000,000 ----------------------------------- Sales 1,000,000 CGS -600,000 Gross profit 400,000 - Operating exp - 30,000 Net income 370,000 Allowance Method A/R 1,000,000 - uncollectible - 500,000 Net realizable 500,000 ------------------------------------- Sales 1,000,000 CGS -600,000 Gross profit 400,000 • Operating exp - 30,000 • Bad debt exp- 500,000 Net loss -130,000 3

4. GAAP Required Balance Sheet Presentation: • All receivables should be reported their . . . Realizable Value • This is the net amount that the company can reasonably expect to collect in cash. 4

5. they estimate amounts they think are uncollectible. • Use a CONTRA Accounts Receivable account called: • Allowance for Doubtful Accounts Companies don’t know which or when specific receivables will be bad, so . . . . 5

6. Example: Accounts Receivable reporting Konk Co. has sales of $5,000,000, of which $700,000 remains uncollected at year end. At year end, December 31, the credit manager estimates $92,000 will prove uncollectible. 6

7. Konk Co. Balance Sheet (partial) Called “Cash (net) Realizable Value” = expected cash collections Current assets Cash $ 14,800 Accounts receivable $700,000 Less: Allowance for doubtful accounts - 92,000 608,000

8. Recording estimates in the Allowance Account: • When . . . Review all A/R at same time adjusting entries are made (at period end) • How . . . Many techniques. Age of A/R is most common method (shown later) • Adjusting Journal entry: BAD DEBT EXPENSE xxxx Allowance for Doubtful Accounts xxxx 8

9. Bad Debt Expense: • is an operating expense on the Income Statement. • is an estimate. • Determining a certain debt is bad won’t be known until some time in the future (maybe a couple of years!). • - Occurs when a specific customer’s A/R is found out to be worthless. (bankruptcy, etc.) • - Journal entry is made at this time called a “Write off” • Allowance for Doubtful Accounts xxxx • Accounts Receivable xxxx 9

10. Go back to previous Example Konk Co. has credit sales of $5,000,000, of which $700,000 remains uncollected at year end. The credit manager estimates $92,000 will prove uncollectible. 12/31 Adjusting entry to record allowance and bad debt: Bad Debt Expense 92,000 Allowance for Doubtful Accounts 92,000 10

11. Allowance for Doubtful Accounts Accounts Receivable Jan 1 Bal700,000 Mar 1 500 Mar 1 500 Jan 1 Bal92,000 Mar 1 Bal699,500 Mar 1 Bal91,500 Now assume a write-off is needed: On March 1 of next year, a write-off is needed for $500 owed by I. M. Bad who went bankrupt. Allowance for Doubtful Accounts 500 Accounts Receivable 500 11

12. Effect of a write off: Before Write-offAfter Write-off Accounts receivable $700,000 $699,500 Allowance for doubtful accts - 92,000- 91,500 Cash realizable value $608,000 $608,000 12

13. PROCESS of ESTIMATION First breakout A/R into classes based on how old they are. Called an aging schedule. Multiply each class by bad debt %. Older classes have higher %. (less likely they will be paid!) This result is the desired ending balancein the allowance account. Entry adjusts existing balance to desired balance. Estimating Bad Debts - Aging Receivables 13

14. Accounts Receivable AGING Schedule 14

15. ALLOWANCE FOR DOUBTFUL ACCOUNTS 100. 1900. EXAMPLE: A/R: Not Due Yet 10,000 1-30 days past 4,000 31 and older 2,000 16,000 Allowance for doubtful accounts 100 credit Bad debts = 5% of not due, 10% of 1-30 past, 50% over 30. .05 x 10000= 500 .10 x 4000= 400 .50 x 2000=1000 1900 ???? Bad debt expense 1,800 Allowance for doubtful accounts 1,800 15

16. 75. 60. 230. 455. 355. 580. 190. ALLOWANCE FOR DOUBTFUL ACCOUNTS 100. 1800. 1900. Estimated side Actual side 45. 16

17. Bad Debt Alternative- DIRECT CHARGE OFF • Allowance not used. (This is a crumby method) • Wait to record bad debt expense when a specific A/R is found to be uncollectible. BAD DEBT EXPENSE xxxx A/R xxxx • A/R on balance sheet overstate amounts realistically expected to be received in cash. • Doesn’t match expenses to revenues. • NOT GAAP. Use only if bad debts are negligible. 17

18. Notes Receivable • Normally requires payment of interest • To the Maker, the promissory note is a note payable. • To the Payee, the promissory note is a note receivable. 18

19. Notes Receivable Computing Interest Examples: 19

20. Notes Receivable • On Maturity, maker pays principal + interest • Interest is recorded in period earned Remember “cut off” for adjusting entries. Interest revenue Interest revenue Note received Maturity Year end 20

21. EXAMPLE: On December 1 receive note with Face = $120,000, Life = 90 days, Rate = 10% December 1 Notes Receivable 120,000.00 Cash, Sales, A/R,etc 120,000.00 Use when you get note. Ignore interest to be earned. On maturity, receive: Principal 120,000 + Interest (120,000)(.10)(90/360) = 120,000 + 3,000.00 = 123,000.00. 21

22. If year end is 12/31, record interest earned with adjusting on December 31 Interest Receivable 1,000.00 Interest Income 1,000.00 $3,000 interest for 90 days, so 1/3 is earned in 30 days. 22

23. When note collected at maturity on February 28 CASH 123,000.00 N/R 120,000.00 INTEREST INCOME 2,000.00 INTEREST RECEIVABLE 1,000.00 If they don’t pay when due (dishonor), write-off to allowance or record as A/R if collection still possible. 23

24. Managing Receivables Receivables often viewed as necessary evils of business • Receivables hinder cash flow and extend the operating cycle. • Cash is better, but competition, marketing, consumer’s buying habits and economic conditions make sales on credit critical to generating revenues! 24

25. Methods used in managing receivables • Allow credit card charges - Retailer pays a % fee to card company - Non-payment becomes card companies expense - Bank cards (VISA & MC) are considered same as cash by bank upon deposit. 25

26. Methods used in managing receivables • Sell receivables to a “factor” - Fees are charged. - Customers make payments to factor. - Payment of receivables is usually guaranteed by selling company. - Selling notes receivable is called Discounting. • Provide terms as incentive for customers to pay sooner. (Chapter 5, such as 2/10, n/30) • Require credit references or perform credit checks on customers (Dun & Bradstreet, Equifax) 26

27. Methods used in managing receivables • Monitor collections. Establish policy for overdue accounts. Helpful ratios include: a) A/R Turnover = Net Credit Sales Average A/R Relates to how fast cash is collected. b) Average Collection Period (age of receivables) in days equals: 365 days / receivables turnover. Usually, high turnover is good. Means less money is tied up in receivables, better cash flow. 27