Reporting and Analysing Receivables

CHAPTER

8

• Amounts due from individuals and Amounts due from individuals and companies that are expected to be companies that are expected to be collected in cashcollected in cash

• Frequently classified asFrequently classified as– Accounts receivableAccounts receivable– Notes receivableNotes receivable– Other receivablesOther receivables

Types of ReceivablesTypes of Receivables

Accounts ReceivableAccounts Receivable

• Amounts owed by customers on accountAmounts owed by customers on account• From sale of goods/services (trade)From sale of goods/services (trade)• Normally expected to be collected within 30 Normally expected to be collected within 30

daysdays• Most significant type of claim held by Most significant type of claim held by

companycompany

Notes ReceivableNotes Receivable

• Claims for which formal instruments of credit are Claims for which formal instruments of credit are issued as evidence of debtissued as evidence of debt

• The credit instrument normally requires the The credit instrument normally requires the debtor to pay interest and extends for time debtor to pay interest and extends for time periods of 30 days or longerperiods of 30 days or longer

• Notes receivable can be current or long-termNotes receivable can be current or long-term

Other ReceivablesOther Receivables

• Nontrade including:Nontrade including:– Interest receivableInterest receivable– Loans to company officersLoans to company officers– Advances to employeesAdvances to employees– Refundable income taxesRefundable income taxes– Recoverable sales taxesRecoverable sales taxes

Accounts ReceivableAccounts Receivable

• Recorded when service is provided or at Recorded when service is provided or at point of sale of merchandise on accountpoint of sale of merchandise on account

Accounts ReceivableAccounts Receivable 100100

SalesSales 100100

Allowance MethodAllowance Method

• The The matching principlematching principle dictates that the bad dictates that the bad debt expense must be recorded in the period debt expense must be recorded in the period when the related revenue is earnedwhen the related revenue is earned

• There are many acceptable methods to There are many acceptable methods to estimate uncollectible accounts estimate uncollectible accounts

The Percentage of Receivables The Percentage of Receivables MethodMethod

• Management establishes a percentage Management establishes a percentage relationship between amount of receivables relationship between amount of receivables and expected losses from uncollectible and expected losses from uncollectible accountsaccounts

– Apply percentage to total receivablesApply percentage to total receivables– Apply percentage to receivables classified Apply percentage to receivables classified

according to the length of time they have according to the length of time they have been outstanding (known as aging the been outstanding (known as aging the accounts receivable)accounts receivable)

Recording Estimated UncollectiblesRecording Estimated Uncollectibles

Abrams Furniture has credit sales of $1,200,000, of Abrams Furniture has credit sales of $1,200,000, of which $200,000 remains uncollected. The credit manager which $200,000 remains uncollected. The credit manager estimates $11,000 will prove uncollectible. The adjusting estimates $11,000 will prove uncollectible. The adjusting entry must take into consideration any opening balance entry must take into consideration any opening balance in the allowance account to pick up amounts from prior in the allowance account to pick up amounts from prior years that are still outstanding.years that are still outstanding.

Bad Debts ExpenseBad Debts Expense xxxxxxxx

Allowance for Doubtful AccountsAllowance for Doubtful Accounts xxxxxxxx

Recording Estimated UncollectiblesRecording Estimated Uncollectibles

The percentage of The percentage of receivables method receivables method gives you the gives you the BALANCE BALANCE in the in the Allowance account, Allowance account, not the amount of the not the amount of the adjustment.adjustment.

Bad Debts ExpenseBad Debts Expense 10,00010,000

Allowance for Doubtful AccountsAllowance for Doubtful Accounts 10,00010,000

Adj. entryAdj. entry 10,000 10,000

Dec. 31 Bal. 11,000Dec. 31 Bal. 11,000

Allowance for Allowance for Doubtful AccountsDoubtful Accounts

Jan. 1 Bal. 1,000Jan. 1 Bal. 1,000

HAMPTON FURNITUREHAMPTON FURNITUREBalance Sheet (partial)Balance Sheet (partial)

Current AssetsCurrent Assets

CashCash $ 14,800$ 14,800

Accounts receivableAccounts receivable $200,000$200,000

Less: Allowance for doubtful accountsLess: Allowance for doubtful accounts 11,00011,000 189,000189,000

Net realizable valueNet realizable value

Net Realizable ValueNet Realizable Value

• Net amount expected to be collected in cashNet amount expected to be collected in cash• Excludes amounts the company estimates it Excludes amounts the company estimates it

will not collectwill not collect• Keeps receivables from being overstated on Keeps receivables from being overstated on

the balance sheetthe balance sheet

Write-Off of anWrite-Off of an Uncollectible Account Uncollectible Account

The vice president of finance authorizes a The vice president of finance authorizes a write-off of $2,500 owed by T. O. Ebbet: write-off of $2,500 owed by T. O. Ebbet:

Accounts ReceivableAccounts ReceivableAllowance for Allowance for

Doubtful AccountsDoubtful Accounts

Jan .1 Bal 227,500Jan .1 Bal 227,500 Mar. 1 2,500Mar. 1 2,500

Mar. 1 Bal 225,000Mar. 1 Bal 225,000

Jan .1 Bal 11,000Jan .1 Bal 11,000Mar. 1 2,500Mar. 1 2,500

Mar. 1 Bal 8,500Mar. 1 Bal 8,500

Bad Debts ExpenseBad Debts Expense 10,00010,000

Allowance for Doubtful AccountsAllowance for Doubtful Accounts 10,00010,000

Recovery of an Uncollectible AccountRecovery of an Uncollectible Account

Accounts Receivable—EbbetAccounts Receivable—Ebbet 2,5002,500

Allowance for Doubtful AccountsAllowance for Doubtful Accounts 2,5002,500

CashCash 2,5002,500

Accounts ReceivableAccounts Receivable 2,5002,500

Record in two separate entriesRecord in two separate entries

Notes ReceivableNotes Receivable

• Result from sale of goods and services Result from sale of goods and services (trade)(trade)

• Stronger legal claim to assets than accounts Stronger legal claim to assets than accounts receivable; written promise (promissory note) receivable; written promise (promissory note) to repayto repay

• Negotiable instruments and may be Negotiable instruments and may be transferred to another party by endorsementtransferred to another party by endorsement

Notes ReceivableNotes Receivable

• Credit instrument normally requiresCredit instrument normally requires– Payment of interest Payment of interest – Extends for time periods of 60-90 days or Extends for time periods of 60-90 days or

longerlonger• Often accepted from customers who need to Often accepted from customers who need to

extend payment of an account receivableextend payment of an account receivable• Often required from high risk customersOften required from high risk customers

Notes ReceivableNotes Receivable

• Interest is charged as: Interest is charged as: Principal x Rate x TimePrincipal x Rate x Time

• Interest is Interest is alwaysalways quoted using annual ratesquoted using annual rates– For example, a six-month $10,000 note at 4% For example, a six-month $10,000 note at 4%

means that the annual rate of interest is 4%means that the annual rate of interest is 4%

– Interest would be $10,000 x 4% x 6/12Interest would be $10,000 x 4% x 6/12

• To record note receivable:To record note receivable:

Dr. Note receivable (face value)Dr. Note receivable (face value)

Cr. Cash, A/R, or SalesCr. Cash, A/R, or Sales

Managing ReceivablesManaging Receivables

• Determine to whom to extend creditDetermine to whom to extend credit• Establish a payment periodEstablish a payment period• Monitor collectionsMonitor collections• Evaluate receivables balanceEvaluate receivables balance• Accelerate cash receipts from receivables when Accelerate cash receipts from receivables when

necessarynecessary

Credit RiskCredit Risk

• Risk of nonpayment of account Risk of nonpayment of account concentrated by customer or concentrated by customer or geographicallygeographically

• Disclose Disclose concentration of credit riskconcentration of credit risk

Evaluating the Receivables Evaluating the Receivables BalanceBalance

• Liquidity is measured by how quickly certain Liquidity is measured by how quickly certain assets can be converted into cashassets can be converted into cash– Receivables turnoverReceivables turnover– Average collection periodAverage collection period

• Is a measure of the liquidityIs a measure of the liquidity of receivablesof receivables

Receivables TurnoverReceivables Turnover

Receivables Turnover =Receivables Turnover =Net Credit SalesNet Credit Sales

Average Gross Average Gross ReceivablesReceivables

• Is the average amount of time that Is the average amount of time that a receivable is outstandinga receivable is outstanding

Average Collection PeriodAverage Collection Period

Average Collection Period =Average Collection Period = 365 days365 days

Receivables TurnoverReceivables Turnover

Credit and Debit Card SalesCredit and Debit Card Sales

• These sales have a cost to the business, These sales have a cost to the business, which must be recorded at the times of salewhich must be recorded at the times of sale

• For example, the business may have to pay For example, the business may have to pay the credit card company 2% for each salethe credit card company 2% for each sale

• A sale of $100 would be recorded as A sale of $100 would be recorded as follows:follows: Dr. A/R—Credit card (or Cash) Dr. A/R—Credit card (or Cash) 98 98

Dr. Service Charge Expense Dr. Service Charge Expense 2 2 Cr. Sales Revenue Cr. Sales Revenue 100 100