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Receivables

Receivables. Chapter 9. Receivables. Monetary Claims Arise from selling goods and services on credit and lending money Two major types Accounts Receivable – current asset Notes Receivable – current or long-term asset depending on when the note matures. Objective 1.

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Receivables

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  1. Receivables Chapter 9

  2. Receivables • Monetary Claims • Arise from selling goods and services on credit and lending money • Two major types • Accounts Receivable – current asset • Notes Receivable – current or long-term asset depending on when the note matures

  3. Objective 1 Design internal controls for receivables

  4. Internal Controls & Receivables • Separation of cash-handling and cash- accounting duties • Establish credit department • Evaluates customers for credit worthiness • Pursues collection from customers

  5. Receivables & Accounting Issues • Balance Sheet should report receivables at the amount the company expects to collect (net realizable value) • Income Statement should report the expense associated with the failure to collect (uncollectible accounts expense)

  6. Objective 3 Understand the direct write-off method for uncollectibles

  7. Direct Write-Off Assume that on November 9, 2006 we sell on account, 2/10, n/30 $5,000 of merchandise. What’s the journal entry to record the sale? Nov 9 Accounts Receivable 5,000 Sales 5,000 Record sale on account

  8. Direct Write-Off Method Assume that it is April 30 of the next year and the company has determined that it will not be able to collect on this account. Prepare the journal entry Apr 30 Uncollectible Accounts Expense 5,000 Accounts Receivable 5,000 To write off a bad debt

  9. Direct Write-Off Method Nov 9 Dec 31 End of Fiscal Year Apr 30 Sale Recorded Expense Recorded Expenses should be matched with revenues in same accounting period. Bad debts arising from 2006 sales should be treated as 2006 expenses. The direct write-off method violates the matching principle. This method is acceptable only when uncollectibles are very low

  10. Objective 2 Use the allowance method to account for uncollectibles

  11. Allowance Method Nov 9 Dec 31 End of Fiscal Year Apr 30 The Allowance Method has two advantages: 1. Expenses are matched with revenues in the same accounting period 2. Accounts Receivables are reported on balance sheet at the amount of cash expected to be collected Prepare adjusting entry based on estimates

  12. Operating expense Contra-asset account Allowance Method Dec 31 Uncollectible Accounts Expense Allowance for Uncollectible Accounts To estimate bad debts for period

  13. Allowance Method Gross amount Accounts Receivable – reported on balance sheet at its “net realizable value” Accounts Receivable $750,000 Allowance for Doubtful Accounts (3,500) $746,500 Estimated uncollectible Expected to be collected

  14. Estimating Uncollectibles • Two Methods • Percent of Sales – Income Statement Approach • Aging of Accounts Receivable – Balance Sheet Approach

  15. Percent of Sales Method Bad debts expense = Net Credit Sales x Bad Debt %

  16. S9-3 Dec 31Uncollectible accounts expense 7,000 Allowance for uncollectible accounts 7,000 Expense = (350,000 x .02) = 7,000 When you use the percentage of sales method, you are estimating the amount of the bad debts expense. Since temporary accounts start the accounting period with a -0- balance, all you have to do is take the percentage times the revenue

  17. S9-3 Allowance for Uncollectible Accounts Accounts Receivable 40,000 Bal -0- 7,000 Bal 7,000 Balance Sheet (partial): Accounts receivable $40,000 Less: Allowance for uncollectible accounts (7,000) Accounts receivable, net $33,000

  18. Aging of Accounts Receivable Method • Accounts receivables are grouped according to age • Each age group has a different likelihood of being uncollectible (the older the receivable, the less likely it will be collected) • Add uncollectible amounts together to compute desired balance in the Allowance for Uncollectible Accounts

  19. E9-17 This method is called the balance sheet approach because you are estimating the balance that should be in the Allowance for Uncollectible Accounts after posting the adjusting entry Desired balance in Allowance for Uncollectible Accounts $11,500

  20. E9-17 Notice: The accounts debited and credited are the same using either the income statement approach or the balance sheet approach. It is the way the estimated amounts are computed that vary. If the desired balance is $11,500 and you already have $8,900 in the account, you need to credit the account for $2,600 more Allowance for Uncollectible Accounts Accounts Receivable 300,000 Bal 8,900 2,600 Bal 11,500 Dec 31Uncollectible accounts expense 2,600 Allowance for uncollectible accounts 2,600 Hint: With the percentage of sales method, you do not have to worry about the balance in the allowance to determine the dollar amount in the adjusting entry. With the aging of receivables method, you do need to consider the existing balance in determining the amount

  21. E9-17 Allowance for Uncollectible Accounts Accounts Receivable 300,000 Bal 8,900 2,600 Bal 11,500 Balance Sheet (partial): Accounts receivable $300,000 Less: Allowance for uncollectible accounts (11,500) Accounts receivable, net $288,500

  22. Writing Off Uncollectible AccountsS9-7 Jan 19 Allowance for Uncollectible Accounts 600 Accounts Receivable - Lance Emmert 600 To write off an account Under the allowance method, the expense is recognized as an adjusting entry. The balance in the Allowance account represents the amount of uncollectible receivables. When a specific account is determined to be uncollectible during the year, the allowance account needs to be reduced (debit) as does the accounts receivable (credit). This journal entry has no effect on the net receivables

  23. Writing Off Uncollectible AccountsS9-7 Dec 31 Accounts Receivable-Lance Emmert 600 Allowance for Uncollectible Accounts 600 To re-instate an account already written off 31 Cash 600 Accounts Receivable-Lance Emmert 600 To record collection on account When an account already written off is collected, reverse the first entry and then record the receipt of cash. Even though Accounts Receivable is credited in the first entry and debited for the same amount in the second entry, it is important to show in your records that the account was re-established and then paid off

  24. Credit Card, Bankcard, Debit-Card Sales One way to avoid risk of Bad Debts is to accept credit cards like Visa or American Express. The credit card company charges the retailer a fee (between 1 and 5% of the charge). Bank credit cards are deposited in bank like cash. Record a debit to cash and Bankcard Discount Expense and credit Sales Revenue Other credit cards receipts, like Discover and American Express, must be debited to Accounts Receivable until the cash is actually collected. Debit-Card Sales: Just like a cash transaction, no discount expense.

  25. S9-8 Account Receivable-American Express 9,800 Credit-Card Discount Expense 200 Sales Revenue 10,000 Cash 7,880 Bankcard Discount Expense 120 Sales Revenue 8,000

  26. Objective 4 Account for notes receivable

  27. Notes Receivable • A note is a written promise to pay a specific amount at a specific future date • Interest - price paid by a borrower for using a lender’s money

  28. Notes Receivable Interest starts PROMISSORY NOTE ______________ _____________ Amount Date For value received, I promise to pay to the order of First National Bank __________________________________ Dollars on ______________________________ plus interest at the annual rate of 12%. ________________________ Oct. 4, 2007 $10,000.00 Payee Principal Ten thousand and no/100--------------------- January 2, 2008 Maker Maturity Date Interest Rate Jeanette Sims

  29. Maturity Value Principal + Interest due at maturity

  30. Identifying Maturity Date • Stated in terms of months - maturity date is determined by counting the months from the date of issue, and falls on same day of the month as date the note was issued • Stated in terms of days - maturity date is determined by counting the days from the date of issue (do not count the day on which the note is dated, but do count the day on which it comes due)

  31. Determine the Maturity Date • A 60-day note dated Oct 4, 2006 is issued. Determine the due date: Number of days on note 60 Days in October 31 Date of note 4 Days outstanding in October 27 Days remaining on note 33 Days in November 30 December due date 3

  32. If the note is expressed in days, base a year on 360 days. If the note is expressed in months, base a year on 12 months Computing Interest Interest = Principal x Interest Rate x Time Remember, the interest rate is an annual rate. If you take Principal x Interest rate, you compute the amount of interest on a one year note. This is why you must multiply by the time the note is outstanding

  33. S9-9 Note 1: $50,000 x 10% x 3/12 = $1,250 Note 2: $10,000 x 9% x 60/360 = $150 Note 3: $15,000 x 12% x 75/360 = $375 Note 4: $100,000 x 8% x 6/12 = $4,000

  34. Accounting for Notes ReceivableS9-10 First – what is the due date? Number of days on note 90 Days in May 31 Date of note 6 Days outstanding in May 25 Days remaining on note 65 Days in June 30 35 Days in July 31 Due date in August 4 May 6 Note Receivable-B Milam 100,000 Cash 100,000 Aug 4 Cash Interest Revenue 2,500 Note Receivable-B Milam 100,000 Next – what is the amount of interest on this note? 100,000 x .1 x 90/360 = 2,500

  35. Accruing Interest Revenue Date of Note, Aug 1, 2008 End of Fiscal Year, Dec 31, 2008 Maturity Date, Aug 1, 2009 Prepare adjusting entry to record interest earned in 20X8 In the previous example, the note was created and matured within the same accounting period. In E9-8, the note spans two accounting periods. When a note spans two accounting periods, you need to allocate some of the interest to each period. In this example, 5 months’ interest would be accrued for 2008 (Aug 1-Dec 31). The other 7 months’ of interest would be recognized in 2009

  36. E9-8 • 2008 • Feb 12 Bankcard Discount Expense 2,000 • Cash 98,000 • Sales 100,000 • Aug 1 Notes Receivable – J Porter 20,000 • Cash 20,000 • Dec 31 Interest Receivable 1,000 • Interest Revenue 1,000 • (20,000 x .12 x 5/12)

  37. E9-8 Eliminate balance carried forward from last year now that you have actually received the interest payment • 2009 • Aug 1 Cash 22,400 • Interest Receivable 1,000 • Interest Revenue 1,400 • Note Receivable – J Porter 20,000 Interest revenue = 20,000 x .12 x 7/12

  38. Dishonored Notes Receivable When a maker of the note defaults on the note, the maturity value of the note receivable is transferred to accounts receivable because the note has expired • Accounts Receivable 10,100 • Interest Revenue 100 • Note Receivable 10,000

  39. Objective 5 Report receivables on the balance sheet

  40. Reporting Receivables Two approaches: Accounts receivable $5,000 Less: Allowance for uncollectible accounts (500) Accounts receivable, net $4,500 Or Accounts receivable, net of allowancefor uncollectible accounts of $500 $4,500

  41. Objective 6 Use the acid-test ratio and days’ sales in receivables to evaluate a company

  42. Acid-Test Ratio • Also called the “quick ratio” • Stringent measure of liquidity • Measures entity’s ability to pay its current liabilities immediately (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities

  43. E9-23 (a) (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities For 20X8: (10,000 + 11,000 + 68,000) ÷ 107,000 = .83 For 20X9: (3,000 + 23,000 + 53,000) ÷ 104,000 = .76 The acid-test ratio is not as good in 2009 as it was in 2008. Cherokee’s acid-test ratio for 2009 is slightly lower than the industry average of .80

  44. Days’ Sales in Receivables • Also called “collection period” • How many days does it take to collect the average level of receivables?

  45. Days’ Sales in Receivables Average net A/R = (Beginning net receivables + Ending net receivables)/2 One day’s sales = Net sales ÷ 365 days Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales

  46. E9-24 One day’s sales = 600,060 ÷ 365 days = $1,644 Days’ sales in average accounts receivable = ((42,800 + 38,200)/2) ÷ 1,644 = 40,500 / 1,644 = 24.6 days Answer to part 2: Swiftmedia’s collection period of 25 days is a little shorter than the company’s normal credit terms of 30 days. This is good for the company because it means the company receives cash quickly and can put its cash to work with little delay

  47. End of Chapter 9

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