BUS210

Cash and Accounts

Receivable

Current Asset Classification

A current asset is defined as any asset that is intended to be converted into cash within one year or the company’s operating cycle, whichever is longer.

i.e., Cash, Marketable Securities, Accounts Receivable, Inventory, Supplies, Prepaids

Proper Cash Management

• Restrictions placed on a company’s

access to its cash are typically imposed by

creditors to help ensure future interest and

principal payments, i.e., loan or debt covenants.

• Compensating balances are sometimes

required

• Control Record over cash, i.e., bank

reconciliation

• Physical Control over cash, i.e., petty

cash, signatures on checks

Accounts Receivable • Accounts receivable arise from selling goods or

services to customers on account.

• Recorded at face amount to be collected.

• However, we must also reflect the fact that a portion of A/R may not be collected. – Net Realizable Value

• Reasons for lack of collection:

1. sales discounts (cash discounts)

2. sales returns

3. sales allowances

4. uncollectible A/R (bad debts, doubtful accounts)

Cash/Sales Discounts • Offered to encourage early payment

• Examples • 2/10, net 30

• 2/10, EOM

• Accounting approaches • Gross Method - records discounts when taken

by customers

• Net Method - records discounts not taken by customers

E6-4 Accounting for cash discounts On May 1, 2015, Crab Cove Fishing Company sold Maine lobster on account for a gross price of $30,000. On May 5, the company sold cod on account for a gross price of $20,000. the terms of both sales were 3/10, n/30. Crab Cove received payment for the first sale on May 6, 2015, and the payment for the second sale on May 31,2015. Provide all necessary journal entries. a. Assume the Gross Method.

E6-4 Accounting for cash discounts On May 1, 2015, Crab Cove Fishing Company sold Maine lobster on account for a gross price of $30,000. On May 5, the company sold cod on account for a gross price of $20,000. the terms of both sales were 3/10, n/30. Crab Cove received payment for the first sale on May 6, 2015, and the payment for the second sale on May 31,2015. Provide all necessary journal entries. b. Assume the Net Method.

P6-2 Cash Discounts/Sales Discounts During March the following credit sales and collections occurred. Company prepares quarterly financials. Required: Prepare the journal entries to record these transactions. March 3 Sold goods to AAA for a gross price of $1,400. Terms 2/10,n/30. March 8 Sold goods to BBB for a gross price of $800. Terms 2/10, n/30. March 11 Received full payment from AAA. March 28 Received full payment from BBB. March 29 Sold goods to CCC for a gross price of $1,800. Terms 2/10, n/30.

Sales Returns and Allowances

• Internal control

• Customer returns and allowances tracked

Direct Write-off Method for AR

• Used primarily in Cash Basis Accounting

• No adjusting journal entry

• Write-off entry

• Recovery entry

Accounting for Bad Debts

Specific

Write-off or

Allowance

Method?

Specific Write-off Method:

Recognize Bad Debts Expense

when individual accounts are

determined to be uncollectible

Allowance Method:

Estimate Bad Debts Expense each year

and reduce Accounts Receivable using

a contra account. Move the reduction from

the contra to the Accounts Receivable

account when a specific account

is known to be uncollectible

Entry:

Bad Debts Exp. xx

Accounts Rec. xx

Which

method is used

to estimate bad

debts expense?

% of Accounts Receivable Method

Recognize Bad Debts Expense for the

amount that will cause the contra

account balance to equal the % of year-

end accounts receivable not expected to

be collected.

% of Sales Method

Recognize Bad Debts Expense for the

amount of bad debts expected to result

from the current year’s sales, using a

percent of sales

Aging of Accounts Receivable Method

Same as the % of Accounts Receivable Method

except it uses different percentages for accounts

based on their age -- higher % for older accounts.

Journal Entries for Allowance Method on next slide

To record bad debts expense:

Bad Debts Expense xxx

Allowance for Uncollectible Accounts xxx

To write off bad accounts:

Allowance for Uncollectible Accounts xxx

Accounts Receivable xxx

Journal Entries for Allowance method of

Accounting for Bad Debts

Recovery of Bad Debts

If a receivable is collected after it has been written off, it should be restored

by making the reverse of the entry that was made to write it off:

Allowance Method

Accounts Receivable xxx

Allowance for Bad Debts xxx

Specific Write-Off Method

Accounts Receivable xxx

Bad Debts Expense xxx

The collection of the receivable is then recorded in the usual fashion:

Cash xxx

Accounts Receivable xxx

Allowance for Doubtful Accts. (T-account)

Allowance for Doubtful Accts.

Beginning Balance

AJE estimates bad debt expense

Bad Debts Expense

AJE estimates bad debt expense

Accounts Receivable

Write-off of accounts receivable

Ending Balance

Customer pays AR Write-off

The AJE to record the estimate of uncollectibles. Aging calculates the expense amount necessary to achieve the “desired ending balance” in the allowance account. OR % of Sales is the Expense and then compute EB in Allowance account.

Recover write-off

Beginning Bal.

Credit sales

Recover write

off

Ending Bal.

BE6-1 Analysis of AR: The following information was taken from the 2012 Annual report of Emerson Electric Co. Balance Sheet (in millions):

Receivables were in 2012 $4,983 and in 2011 $4,502; less allowance for uncollectibles of $109 and $104, respectively. a. Compute total AR as of the end of 2012 and 2011, and compute the bad

debt allowance as a % of total AR. Did the % increase or decrease?

b. The bad debt expense reported on Emerson’s 2012 income statement did not equal $109. Explain why.

Note on estimating bad debts using the allowance method:

Regardless of which method is used to estimate bad debts

(% of sales, % of accounts receivable, or aging of

accounts), in the final analysis the balance in the allowance

account on the balance sheet should represent a fair

expectation of the amount that will not be collected of the

outstanding accounts receivable. Hence, the net accounts

receivable balance on the balance sheet should represent

the expected “net realizable value” of the receivables.

Estimating Bad Debt Expenses

• Percent of Sales Method

• Percent of Accounts Receivable Method

• Aging of Accounts Receivable Method

Bad Debts/Doubtful Accounts/Uncollectible Accounts

• Note that we do not know in this year which A/Rs will not be collected in future. Therefore, we must estimate uncollectibles.

• We will focus on the % of Sales or Aging of AR to estimate uncollectibles for the AJE. The percentage of sales method is simpler, but the Aging of A/R method is more accurate.

• Under IFRS, the methods used to estimate and

account for uncollectible are very similar to those under US GAAP.

Percentage of Sales Method • Usually based on credit sales, but may use

total sales or net sales as basis.

• Calculation:

Sales x % = Bad Debt Expense

(focus on the debit side of the AJE)

• Called the Income Statement approach, because: revenues x % = expense.

• After making entry find the resulting ending balance in the Allowance account.

E6-5 Bad debts under the allowance method.

Arlington Cycle Company began operations on 1/1/14. The company reported the following on its 2015 financials: Gross sales in 2015 $1,400,000 and $1,500,000 in 2014. AR in 2015 $600,000 and $650,000 in 2014. Actual bad debt write-offs in 2015 $22,000 and $10,000 in 2014. Arlington estimates bad debts at 2% of gross sales. Analyze the activity in the allowance for doubtful accounts T-account, and comment on whether the bad debt estimate has been sufficient to cover the writeoffs.

Gross sales in 2015 $1,400,000 and $1,500,000 in 2014. AR in 2015 $600,000 and $650,000 in 2014. Actual bad debt write-offs in 2015 $22,000 and $10,000 in 2014. Arlington estimates bad debts at 2% of gross sales.

P6-3 Bad debts over time The company estimates bad debts at 3% of credit sales. The beginning balance in the Allowance for doubtful accounts as of the beginning of 2013 was $10,000.

a. Provide the journal entries related to the Allowance account for all three years.

2015 2014 2013

Credit sales $205,000 $200,000 $180,000

Actual bad debt write-offs 11,000 10,000 6,000

P6-3 Bad debts over time The company estimates bad debts at 3% of credit sales. The beginning balance in the Allowance for doubtful accounts as of the beginning of 2013 was $10,000.

b. Compute the balance in the allowance account at 12/31/15.

c. Comment on the sufficiency of the bad debts expense and the allowance over the 3 years.

2015 2014 2013

Credit sales $205,000 $200,000 $180,000

Actual bad debt write-offs 11,000 10,000 6,000

P6-4 Uncollectibles over two periods Company uses the percentage-of-net-sales method to account for bad debts. Historically, 3% of net sales have proven to be uncollectible. During 2014 and 2015:

a. Prepare the necessary adjusting entries on 12/31/14 to record the estimated bad

debt expense.

b. Assume the 1/1/2014 Allowance account balance was $65,000(credit) and that $70,000 in bad debts were written off during year. What is the 12/31/14 balance after adjustments.

2015 2014

Gross sales $1,500,000 $1,800,000

Sales discounts 100,000 130,000

Sales returns 50,000 20,000

P6-4 Uncollectibles over two periods Company uses the percentage-of-net-sales method to account for bad debts. Historically, 3% of net sales have proven to be uncollectible. During 2014 and 2015:

c. Prepare the necessary adjusting entries on 12/31/15 to record the estimated bad debt expense.

d. What is the 12/31/2015 Allowance balance? Assume that $85,000 in bad debts was written off during the year.

2015 2014

Gross sales $1,500,000 $1,800,000

Sales discounts 100,000 130,000

Sales returns 50,000 20,000

Aging Method: Percentages of A/R

• Based on ending A/R and ending Allowance account.

• Calculation:

Ending A/R x % = Ending Allowance

(focus on the credit side of the AJE)

• Called Balance Sheet approach, because: ending asset x % = ending contra asset.

• Requires the analysis of the Allowance account and A/R before preparing the AJE.

• An aging schedule of A/R is the most accurate way to estimate uncollectibles (see Figure 6-11).

E6-10 Aging schedule preparation Compute the total receivables and expected bad debts as of the end of the year based on the following:

Account age Balance Noncollection Probability

Current $290,000 2%

1-45 days past due 110,000 5%

46-90 days past due 68,000 8%

Over 90 days past due 40,000 15%

Aging of AR

Customer

Account Total Not Yet Due

1–30 Days Past

Due

31–60 Days Past

Due

61–90 Days Past

Due

Over 90 Days Past

Due

Balance Forward $89,640 $49,030 $24,110 $9,210 $3,990 $3,300

Time Percentage Considered Uncollectible

Not yet due 2

1–30 days past due 5

31–60 days past due 15

61–90 days past due 25

Over 90 days past due 50

Emory Company uses the accounts receivable aging method to estimate uncollectible accounts. At the beginning of the year, the balance of the Accounts Receivable account was a debit of $90,430, and the balance of Allowance for Uncollectible Accounts as a credit of $8,100. During the year, the company had sales on account of $475,000, sales returns and allowances of $6,200, worthless accounts written off of $8,800, and collections from customers of $452,730. At the end of year (December 31, 2015), a junior accountant for Emory Company was preparing an aging analysis of accounts receivable. At the top of page 5 of the report, the following totals appeared:

To finish the analysis, the following accounts need to be classified:

From past experience, the company has found that the following rates are realistic for estimating uncollectible accounts:

Required

Complete the aging analysis of accounts receivable. Compute the end-of-year balances (before adjustments) of Accounts Receivable and Allowance for Uncollectible Accounts. Prepare an analysis computing the estimated uncollectible accounts. Calculate Emory Company's estimated uncollectible accounts expense for the year (round the amount to the nearest whole dollar). What role do estimates play in applying the aging analysis? What factors might affect these estimates?

Year-end Entries: Bad Debts • During 2015, Omega Company had net sales of $11,400,000. Most of the sales were on credit. At the

end of 2015, the balance of Accounts Receivable was $1,400,000, and Allowance for Uncollectible Accounts had a debit balance of $48,000.

• Omega Company's management uses two methods of estimating uncollectible accounts expense: the percentage of net sales method and the accounts receivable aging method. The percentage of uncollectible sales is 1.5 percent of net sales, and based on an aging of accounts receivable, the end-of-year uncollectible accounts total $140,000.

1. Prepare the end-of-year adjusting entry to record the uncollectible accounts expense under each method.

2. What will the balance of Allowance for Uncollectible Accounts be after each adjustment?

During 2015, Omega Company had net sales of $11,400,000. Most of the sales were on credit. At the end of 2015, the balance of Accounts Receivable was $1,400,000, and Allowance for Uncollectible Accounts had a debit balance of $48,000. Omega Company's management uses two methods of estimating uncollectible accounts expense: the percentage of net sales method and the accounts receivable aging method. The percentage of uncollectible sales is 1.5 percent of net sales, and based on an aging of accounts receivable, the end-of-year uncollectible accounts total $140,000. 1. Prepare the end-of-year adjusting entry to record the uncollectible accounts expense under each

method. 2. What will the balance of Allowance for Uncollectible Accounts be after each adjustment?

3. Why are the results different? 4. Which method is likely to be more reliable? Why?

Write-off of Accounts Receivable Colby Company, which uses the allowance method, has Accounts Receivable of $65,000 and an allowance for uncollectible accounts of $6,400 (credit). The company sold merchandise to Irma Hegerman for $7,200 and later received $2,400 from Hegerman. The rest of the amount due from Hegerman had to be written off as uncollectible. Using T accounts, show the beginning balances and the effects of the Hegerman transactions on Accounts Receivable and Allowance for Uncollectible Accounts.

What is the amount of net accounts receivable before and after the write-off?

E6-8 Write-offs and Entries The company estimates bad debts each year at 2% of credit sales. End of the year amounts from the annual report are:

a. Compute the actual amount of write-offs during year.

b. Infer the journal entries that explain the accounts receivable and the related allowance accounts activity during the year.

2015 2014

Credit sales $75,300 $61,500

Accounts receivable 9,400 9,200

Allowance for bad debts 1,300 1,000

Bad debt recoveries 55 70

Liquidity Ratios

• Working Capital =CA-CL

• Current Ratio = CA/CL

• Quick Ratio or Acid Test Ratio =

(CA-Inv & Prepaids)/CL How are these ratios affected by the journal entries you will learn this chapter?

Sale on Account:

Cash Collection:

AR Writeoff:

AR Recovery:

Bad Debt AJE:

P6-7 Ignoring Potential Bad Debts Income Statement Balance Sheet

Sales $200,000 Cash $5,000

Cost of goods sold 102,000 Accounts receivable 85,000

Gross profit 98,000 Other assets 40,000

Expenses 65,000 Total assets $130,000

Net income $33,000 Current liabilities 13,000

Long-term NP 80,000

SHE 37,000

Total L + SHE $130,000

The above financial information is for the Hadley Company’s first year of operation. The income statement was not adjusted for bad debt expense. A large percentage of sales were to 3 customers, one of which, Litzenberger Supply is in questionable financial health, although still in business. Litzenberger owes Hadley $50,000 as of the end of first year.

P6-7 continued Required:

a. Adjust the financial statements of Hadley Company to reflect a more conservative reporting with respect to bad debts, i.e. set up a provision. Recompute net income. How does this adjustment affect your assessment of Hadley’s first year of operations?

b. Why would auditors probably require that Hadley choose the more conservative reporting?

c. Hadley’s CFO claims that no bad debt expense should be recorded because Litzenberger is still conducting operations as of the end of year. How would you respond to this claim?