Chapter 8

1. Chapter 8 Reporting andInterpreting Receivables,Bad Debt Expense, andInterest Revenue

2. Amounts owed by other companies or persons for cash, goods, or services. Open accounts owed to the business by trade customers. Accounts Receivable Accounts Receivable

3. Notes Receivable A note receivable is a written contractestablishing the terms by which acompany will receive amounts it is owed. Companies may convert accountsreceivable balances to notes for customerswho are having difficulty paying their receivables.

4. Term January 5, 2008 Payee $1,200 Sixty days after date I promise to pay to Principal Skechers U.S.A., Inc. the order of One thousand two hundred --------------------------------- Dollars Interest Rate First National Bank Payable at 8% Value received with interest atper annum Alan Jones 8563 March 6, 2008 No. Due Jones Athletic Company Due Date Notes Receivable

5. Learning Objective 1 Describe the tradeoffs of extending credit.

6. Extending credit is likely to increasesales, but not without costs: Increased wage costs to manage receivables Delayed receiptof cash Bad debtscosts Pros and Cons of Extending Credit Businesses extend credit togenerate additional sales and tomeet the terms offered by competitors.

7. Learning Objective 2 Estimate and report the effects of uncollectible accounts.

8. Accounts Receivableand Bad Debts Bad debtsresult from credit customers who will not pay the business the amountthey owe, regardless of collection efforts.

9. Accounts Receivableand Bad Debts Bad debts are likely to be discovered inperiods after the credit sale. If bad debts are not reported until discovered,income is distorted in the periods of sale aswell as in the period of bad debt discovery.

10. Matching Principle The Allowance Method of Accounting for Bad Debts Bad Debt Expense Record in same accounting period. Sales Revenue

11. The Allowance Method of Accounting for Bad Debts Most businesses record an estimate ofthe bad debt expensewith an adjustingentry at the end of the accounting period.

12. Record EstimatedBad Debt Expense For the year ended December 31, 2005, Skechers U.S.A., Inc., estimated itsbad debt expense to be $2,882,000. Prepare the adjusting entry.

13. Contra asset account Record EstimatedBad Debt Expense For the year ended December 31, 2005, Skechers U.S.A., Inc., estimated itsbad debt expense to be $2,882,000. Prepare the adjusting entry. Bad Debt Expenseis normally classified as a selling expense and is closed at year-end.

14. Amount the businessexpects to collect. Allowance for Doubtful Accounts Balance Sheet Disclosure

15. When it is clear that a specific customer’s account receivable will be uncollectible, the amount should be removed from the Accounts Receivable account and charged to the Allowance for Doubtful Accounts. Remove (Write Off) Specific Customer Balances

16. Skechers’ total write-offs for2005 were $1,729,000. Prepare a summary journalentry for these write-offs. Remove (Write Off) Specific Customer Balances

17. Remove (Write Off) Specific Customer Balances Skechers’ total write-offs for2005 were $1,729,000. Prepare a summary journalentry for these write-offs.

18. Remove (Write Off) Specific Customer Balances Assume that before the write-off, Skechers’ Accounts Receivable balance was $56,000,000 and the Allowance for Doubtful Accountsbalance was $6,043,000. Let’s see what effect the total write-offs of $1,729,000 had on these accounts.

19. Remove (Write Off) Specific Customer Balances Notice that the total write-offs of $1,729,000 did not change the net accounts receivable value nor did it affect any income statement accounts.

20. Aging of Accounts Receivable ???? Estimating Bad Debts Focus is on determining the desired balance in theAllowance for Doubtful Accountson the balance sheet.

21. Each customer’s account is aged by separating the total amount owed by each customer into aging categories based on the number of days that have passed since uncollected amounts were first recorded in the account. Let’s look on the next slide to see an aging of accounts receivable for Skechers (all amounts in thousands). Aging Schedule

22. Aging Schedule (in thousands) Next, based on past experience, the business estimates the percentage of uncollectible accounts in each time category.

23. Aging Schedule (in thousands) Now we will multiply these percentages by the appropriate column totals.

24. Aging Schedule (in thousands) The column totals are then added to arrive at the total estimate of uncollectible accounts of $7,196.

25. Record the year-end adjusting entry assuming that the Allowance for Doubtful Accounts currently has a $4,314,000 credit balance. Aging of Accounts Receivable (in thousands)

26. Aging of Accounts Receivable After posting, the Allowance account would look like this . . .

27. Aging of Accounts Receivable Notice that the balance after adjustment is equal to the estimate of $7,196,000 based on the aging analysis performed earlier.

28. Other Issues – Account Recoveries Collections of accounts previously written off require that the original write-off entry be reversed before the cash collection is recorded. Let’s record the entry that Skechers would make if $50,000 is collected that had previously been written off.

29. Learning Objective 3 Compute and report interest on notes receivable.

30. Notes Receivable andInterest Revenue Accounting for notes receivableis similar to accounting foraccounts receivable except for interest. Accounts receivable do notcharge interest until theybecome overdue, but notesreceivable start charginginterest the day they are created.

31. Even for maturities less than 1 year, the rate is annualized. Number of months out of twelvethat interest period covers. Calculating Interest

32. Reporting Interest onNotes Receivable On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008. Recordnotereceivable Record interestand principal received Accrueinterest 2007 Interest 2008 Interest 11/01/07 12/31/07 10/31/08

33. Recording Notes Receivable On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008. On November 1, to record the note:

34. Accruing Interest Earned On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008. × × $ 2,000 = $ 100,000 12% 2/12 Interest revenue is $1,000 per month.

35. Accruing Interest Earned On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008. On December 31, to accrue $ 2,000 interest receivable:

36. Recording Interest Receivedand Principal at Maturity On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008. On October 31, to record $112,000 cash received:

37. Accounting for Uncollectible Notes When the collection of a note receivable is in doubt,a company should record anallowance for doubtful accounts against notes receivable justas is done with accountsreceivable.

38. Learning Objective 4 Compute and interpret the receivables turnover ratio.

39. Receivables TurnoverRatio Net Credit Sales RevenueAverage Net Trade Receivables = Receivables Turnover Analysis Skechers reported 2005 net credit sales of $1,006,000,000.December 31, 2005, receivables were $134,600,000 andDecember 31, 2004, receivables were $120,400,000.

40. Receivables TurnoverRatio Net Credit Sales RevenueAverage Net Trade Receivables = $1,006,000,000 ($134,600,000 + $120,400,000) ÷ 2 = Receivables Turnover Analysis = 7.9 times This ratio measures how many times average receivables are recorded and collected for the year.

41. Days to Collect 365 DaysReceivables Turnover Ratio = Days to Collect 365 Days7.9 = = 46.2 Days Receivables Turnover Analysis This ratio tells us the average number of daysit takes a company to collect its receivables.

42. Factoring Receivables When a company desires to quickly convert receivables into cash, the receivables can be sold to a financing company or bank (calledfactoring).

43. Companies accept credit cardsto: To increase sales. To avoid providing credit directly to customers. To avoid losses due to bad checks. To receive payment quicker. Credit Card Sales When credit card sales are made, a fee is paid to the credit card company for the service it provides.

44. Chapter 8Supplement Percentage of Credit Sales Method

45. Percentage of Credit Sales Bad debt percentage is based on actual uncollectible accounts from prior years’credit sales. Focus is on determining the amount to record on the income statement asBad Debt Expense.

46. Percentage of Credit Sales

47. Percentage of Credit Sales In the current year Skechers had credit sales of $1,152,800,000. Past experience indicates that bad debts are one-fourth of one percent (.25%) of sales. What is the estimate of bad debt expense for the year? $1,152,800,000 × .0025 = $2,882,000 Let’s prepare the adjusting entry.

48. Percentage of Credit Sales

49. Direct Write-Off Method No journal entries are made until a bad debt is discovered. The following journal entry is made to record $1,000 of bad debt expense when a customer account is determined to be uncollectible. Acceptable for tax purposes,but unacceptable under generally accepted accounting principles.

50. End of Chapter 8