Accounting for account receivables

1. 7 C H A P T E R Accounting for account receivables

2. What Are Receivables? An account receivable is a current asset representing money due for services performed or merchandise sold on credit. When an account receivable becomes uncollectible, a bad debt expense is incurred.

3. Credit sale: Jan. 10 Accounts Receivable . . . . . . . . . . 1,000 Sales Revenue . . . . . . . . . . . . . 1,000 Sold equipment on account. Collection--2/10, n/30: Jan. 30 Cash. . . . . . . . . . . . . . . . . . . . . . . . 1,000 Accounts Receivable. . . . . . . . 1,000 Payment received n/30. Example: Accounts Receivable On January 10, Carson Cameras sold $1,000 of equipment on account. The terms of the agreement are 2/10, n/30. Payment was received on January 30. What are the entries?

4. Discuss Uncollectible Accounts. Occur when customers do not pay for items or services purchased on credit. When an account receivable becomes uncollectible, a firm incurs a bad debt loss. Recognized as a cost of doing business, so classified as a selling expense (projection of a selling rate). Two ways to account for these losses: the direct write-off method. the allowance method.

5. 11/1/02 Bad Debt Expense. . . . . . . . . . . . . . 4,000 Accounts Receivable . . . . . . . . . 4,000 To write off an uncollectible account for purchases made on 8/1/01. Review The Direct Write-Off Method • Method is objective because bad debt expense is written off at the time it proves to be uncollectible. • However, the method violates the matching principle that says: • All costs and expenses in generating revenues must be identified with those revenues period by period.

6. 8/1/02 Bad Debt Expense. . . . . . . . . . . . . . 4,000 Allowance/Provision for Bad Debts . . . 4,000 To adjust the Allowance account to the desired balance. Discuss The Allowance (Provision) Method • A firm uses its experience or industry averages to estimate the amount of receivables that will be uncollectible. • Allowance for Bad Debts is a contra-asset account that is offset against Accounts Receivable on the balance sheet. • As actual losses are recognized, Allowance for Bad Debts is reduced.

7. Reverse Write-off: Aug. 1 Accounts Receivable . . . . . . . . . . 4,000 Allowance for Bad Debts . . . . . 4,000 To reinstate a written-off receivable. Eliminate Receivable: Aug. 1 Cash. . . . . . . . . . . . . . . . . . . . . . . . 4,000 Accounts Receivable. . . . . . . . 4,000 Payment for written-off receivable. Reversing Written-off Receivables What are the entries if the credit customer eventually pays? Companies must have good control over both cash collection procedures and accounting for accounts receivable; otherwise such payments could be pocketed by an employee who receives cash without the company’s knowledge.

8. Estimating Uncollectible Accounts Receivable What are the three methods? As a percentage of credit sales As a percentage of total receivables Aging accounts receivable

9. AS A PERCENTAGE OF CREDIT SALES AS A PERCENTAGE OF TOTAL RECEIVABLES Estimating Uncollectible Accounts Receivable In practice, a company should consider both techniques to ensure that each yields roughly consistent results.

10. 12/31/01 Bad Debt Expense. . . . . . . . . . . . . . 2,701 Allowance for Bad Debts . . . . . . 2,701 To adjust the Allowance account to desired balance (see pg. 246). Uncollectible Accounts Allowance Norm’s Tools had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for bad debts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected.What is the adjusting entry? Bad Debt Expense Allowance for Bad Debts 350 Bal. Exp. 2,701 2,701 Exp. End. Bal. 2,701 3,051 End. Bal.

11. A more refined and accurate method of estimating the appropriate ending balance in the Allowance for Bad Debts. Requires a company to base its calculations on how long its receivables have been outstanding. Each receivable is categorized according to age, such as Current 1-30 days past due 31-60 days past due, etc. (see pg. 247) The total amount in each classification is multiplied by an appropriate uncollectible percentage (determined by experience). Review Aging Accounts Receivable

12. Uncollectible Accounts Expense Copy That had credit sales during the year of $200,000. Using the aging method and the data on the aging receivables worksheet, determine the journal entry needed. The beginning balance for Allowance for Bad Debts is $150. Aging Receivables Worksheet Percentage Estimated to be AgeBalanceUncollectible Amount Current. . . . . . . . . . $10,000 1.5% $ 150 1-30 days. . . . . . . . 4,000 4.0 160 31-90 days. . . . . . . 2,100 20.0 420 Over 90 days. . . . . 1,000 40.0 400 $17,100 $1,130

13. 12/31/01 Bad Debt Expense. . . . . . . . . . . . . . 980 Allowance for Bad Debts . . . . . . 980 To adjust the Allowance account to desired balance. Uncollectible Accounts Expense Copy That had credit sales during the year of $200,000. Using the aging method and the data on the aging receivables worksheet, determine the journal entry needed. The beginning balance for Allowance for Bad Debts is $150. Bad Debt Expense Allowance for Bad Debts 150 Bal. Exp. 980 980 Exp. (160+420+ 400) End. Bal. 980 1,130 End. Bal.

14. Accounts Receivable Turnover = Comment on Assessing Managementof Receivables Sales Revenue Accounts Receivable • Determines the number of times during a year a company is “turning over” or collecting its receivables. • Measure of how many times old receivables are collected and replaced by new receivables.

15. Comment on Assessing Managementof Receivables 365 days Accounts Receivable Turnover Average Collection Period = • Converts accounts receivable turnover into the number of days it takes to collect receivables. • Proper receivables management involves balancing the desire to extend credit in order to increase sales with the need to collect cash quickly to pay the company’s bills.

16. Accounts Receivable Turnover: Sales Revenue = $150,000 = 3.75 Accounts Receivable $ 40,000 Average Collection Period: 365 = 97.33 days Accounts Receivable Turnover = 3.75 Management of Receivables Adjust It Square had net credit sales of $150,000 during 2001. The accounts receivables increased to $40,000 during the same time. Calculate the accounts receivable turnover ratio and the average collection period.