Receivables

Copyright © 2007 Prentice-Hall. All rights reserved 1

ReceivablesReceivablesReceivablesReceivables

Chapter 8


ReceivablesReceivablesReceivablesReceivables

• 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 1Objective 1Objective 1Objective 1

Design internal controls for receivables


Internal Controls & ReceivablesInternal Controls & ReceivablesInternal Controls & ReceivablesInternal Controls & Receivables

• Separation of cash-handling and cash- accounting duties

• Establish credit department– Evaluates customers for credit worthiness– Pursues collection from customers


Receivables & Accounting IssuesReceivables & Accounting IssuesReceivables & Accounting IssuesReceivables & 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)



Understand the direct write-off method for uncollectibles


Direct Write-OffDirect Write-OffDirect Write-OffDirect Write-Off

GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT

Nov 9 Accounts Receivable 5,000

Sales 5,000

Record sale on account

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?


GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT

Apr 30 Uncollectible Accounts Expense 5,000

Accounts Receivable 5,000

To write off a bad debt

Direct Write-Off MethodDirect Write-Off MethodDirect Write-Off MethodDirect 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


Direct Write-Off MethodDirect Write-Off MethodDirect Write-Off MethodDirect Write-Off Method

Nov 9 Dec 31End of Fiscal Year

Apr 30

Sale Recorded

ExpenseRecorded

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



Use the allowance method to account for uncollectibles


Allowance MethodAllowance MethodAllowance MethodAllowance Method

Nov 9 Dec 31End of Fiscal Year

Apr 30

Prepare adjusting entrybased on estimates

The Allowance Method has two advantages:1. Expenses are matched with revenues in

the same accounting period2. Accounts Receivables are reported on

balance sheet at the amount of cash expected to be collected


GENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

Dec 31 Uncollectible Accounts Expense

Allowance for Uncollectible Accounts

To estimate bad debts for period

Operating expenseOperating expense

Allowance MethodAllowance MethodAllowance MethodAllowance Method

Contra-asset accountContra-asset account


Allowance MethodAllowance MethodAllowance MethodAllowance MethodAccounts Receivable – reported on balance sheet at

its “net realizable value”

Accounts Receivable $750,000

Allowance for Doubtful Accounts (3,500)

$746,500

Gross amount

Estimated uncollectible

Expected to be

collected


Estimating UncollectiblesEstimating UncollectiblesEstimating UncollectiblesEstimating Uncollectibles

• Two Methods – Percent of Sales – Income Statement

Approach– Aging of Accounts Receivable – Balance

Sheet Approach


Percent of Sales MethodPercent of Sales MethodPercent of Sales MethodPercent of Sales Method

Bad debts expense = Net Credit Sales x Bad Debt %


S8-3S8-3S8-3S8-3GENERAL JOURNAL


Dec31Uncollectible accounts expense 7,000

Allowance for uncollectible accounts 7,000

Expense = (350,000 x .02) = 7,000When 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


S8-3S8-3S8-3S8-3

40,000

Accounts ReceivableBal -0-


7,000

Bal 7,000

Balance Sheet (partial):Accounts receivable $40,000Less: Allowance for uncollectible accounts (7,000)Accounts receivable, net $33,000


Aging of Accounts Receivable Aging of Accounts Receivable MethodMethod

Aging of Accounts Receivable Aging of Accounts Receivable MethodMethod

1. Accounts receivables are grouped according to age

2. Each age group has a different likelihood of being uncollectible (the older the receivable, the less likely it will be collected)

3. Add uncollectible amounts together to compute desired balance in the Allowance for Uncollectible Accounts


E9-17E9-17E9-17E9-17

Age of Accounts Receivable

Accounts Receivable

1-30 Days 31-60 Days

61-90 Days

Over 90 Days

$300,000 $140,000 $80,000 $70,000 $10,000

Estimated % uncollectible .5% 2% 6% 50%

Total $700 $1,600 $4,200 $5,000

$11,500Desired balance in Allowance

for Uncollectible Accounts

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


E8-17E8-17E8-17E8-17

300,000

Accounts ReceivableBal 8,900


2,600

Bal 11,500

GENERAL JOURNAL


Dec31Uncollectible accounts expense 2,600

Allowance for uncollectible accounts 2,600

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

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


E8-17E8-17E8-17E8-17

300,000

Accounts ReceivableBal 8,900


2,600

Bal 11,500

Balance Sheet (partial):Accounts receivable $300,000Less: Allowance for uncollectible accounts (11,500)Accounts receivable, net $288,500


Writing Off Uncollectible AccountsWriting Off Uncollectible AccountsS8-7S8-7


GENERAL JOURNAL


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




GENERAL JOURNAL


Dec 31 Accounts Receivable-Lance Emmert 600

Allowance for Uncollectible Accounts 600

To re-instate an account already written off

31 Cash 600Accounts 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


Credit Card, Bankcard, Debit-Card Credit Card, Bankcard, Debit-Card SalesSales

Credit Card, Bankcard, Debit-Card Credit Card, Bankcard, Debit-Card SalesSales

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 RevenueOther 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.


S8-8S8-8S8-8S8-8GENERAL JOURNAL


Account Receivable-AmericanExpress 9,800Credit-Card Discount Expense 200

Sales Revenue 10,000

Cash 7,880Bankcard Discount Expense 120

Sales Revenue 8,000



Account for notes receivable


Notes ReceivableNotes ReceivableNotes ReceivableNotes 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


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%.

________________________

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%.

________________________

Notes ReceivableNotes ReceivableNotes ReceivableNotes Receivable

$10,000.00

Ten thousand and no/100---------------------

Oct. 4, 2007

January 2, 2008

Jeanette Sims

Principal

Payee

Intereststarts

MakerMaturity

Date InterestRate


Maturity ValueMaturity ValueMaturity ValueMaturity Value

Principal + Interest due at maturity


Identifying Maturity DateIdentifying Maturity DateIdentifying Maturity DateIdentifying 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)


Determine the Maturity DateDetermine the Maturity DateDetermine the Maturity DateDetermine the Maturity Date

• A 60-day note dated Oct 4, 2006 is issued. Determine the due date:

Number of days on note 60Days in October 31Date of note 4Days outstanding in October 27Days remaining on note 33Days in November 30December due date 3


If the note is expressed in days, base a year on 360

days.

If the note is expressed in days, base a year on 360

days.

Computing InterestComputing InterestComputing InterestComputing Interest

Interest = Principal x Interest Rate x Time

If the note is expressed in months, base a year on 12

months

If the note is expressed in months, base a year on 12

monthsRemember, 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


S8-9S8-9S8-9S8-9

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


Accounting for Notes ReceivableAccounting for Notes ReceivableS8-10S8-10

Accounting for Notes ReceivableAccounting for Notes ReceivableS8-10S8-10

GENERAL JOURNAL


May 6 Note Receivable-B Milam 100,000Cash 100,000

Aug 4 CashInterest Revenue 2,500Note Receivable-B Milam 100,000

First – what is the due date?

Number of days on note 90Days in May 31Date of note 6Days outstanding in May 25Days remaining on note 65Days in June 30

35Days in July 31Due date in August 4

Next – what is the amount of interest on this note?

100,000 x .1 x 90/360 = 2,500


Accruing Interest RevenueAccruing Interest RevenueAccruing Interest RevenueAccruing Interest Revenue

Date of Note,Aug 1, 2008

End of Fiscal Year,Dec 31, 2008

Maturity Date,Aug 1, 2009

Prepare adjusting entryto record interest earned in 20X8

In the previous example, the note was created and matured within the same accounting period. In E8-8, 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


E8-8E8-8E8-8E8-8GENERAL JOURNAL


2008 Feb 12 Bankcard Discount Expense 2,000

Cash 98,000Sales 100,000

Aug 1 Notes Receivable – J Porter 20,000Cash 20,000

Dec 31 Interest Receivable 1,000Interest Revenue 1,000

(20,000 x .12 x 5/12)


E8-8E8-8E8-8E8-8GENERAL JOURNAL


2009

Aug 1 Cash 22,400Interest Receivable 1,000Interest Revenue 1,400Note Receivable – J Porter 20,000

Interest revenue = 20,000 x .12 x 7/12Interest revenue = 20,000 x .12 x 7/12

Eliminate balance carried forward from last year now that you have

actually received the interest payment


Dishonored Notes ReceivableDishonored Notes ReceivableDishonored Notes ReceivableDishonored Notes Receivable

GENERAL JOURNAL


Accounts Receivable 10,100Interest Revenue 100Note Receivable 10,000

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



Report receivables on the balance sheet


Reporting ReceivablesReporting ReceivablesReporting ReceivablesReporting 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



Use the acid-test ratio and days’ sales in receivables to evaluate a

company


(Cash + Short-term investments + Net current receivables) ÷ Total current liabilities

Acid-Test RatioAcid-Test RatioAcid-Test RatioAcid-Test Ratio

• Also called the “quick ratio”

• Stringent measure of liquidity

• Measures entity’s ability to pay its current liabilities immediately


E8-23 (a)E8-23 (a)E8-23 (a)E8-23 (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


Days’ Sales in ReceivablesDays’ Sales in ReceivablesDays’ Sales in ReceivablesDays’ Sales in Receivables

• Also called “collection period”

• How many days does it take to collect the average level of receivables?


One day’s sales = Net sales ÷ 365 days

Days’ sales in average accounts receivable =Average net accounts receivable ÷ One day’s sales

Days’ Sales in ReceivablesDays’ Sales in ReceivablesDays’ Sales in ReceivablesDays’ Sales in ReceivablesAverage net A/R =

(Beginning net receivables + Ending net receivables)/2


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

E8-24E8-24E8-24E8-24

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


End of Chapter 8End of Chapter 8End of Chapter 8End of Chapter 8

Documents

Receivables