Spiceland | Thomas | Herrmann Financial Accounting Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Receivables and Sales Chapter 5

5-2 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objectives Recognize accounts receivable Calculate net revenues using discounts, returns, and allowances Record an allowance for future uncollectible accounts Use the aging method to estimate future uncollectible accounts Apply the procedure to write off accounts receivable as uncollectible

5-3 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objectives Contrast the allowance method and direct write- off method when accounting for uncollectible accounts Apply the procedure to account for notes receivable, including interest calculation Calculate key ratios investors use to monitor a company’s effectiveness in managing receivables Estimate uncollectible accounts using the percentage-of-credit-sales method

Part A Recognizing Accounts Receivable 5-4 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 1 Recognize accounts receivable 5-5 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-6 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Credit Sales Transfer products and services to a customer today and collecting payment in the future Also known as sales on account or services on account Common for large business transactions

5-7 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Accounts Receivable Cash owed to the company by its customers from sales on account Recorded at the time of the credit sale Also called trade receivables

5-8 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Recording of Credit Sales Link’s Dental charges $500 for teeth whitening. Dee Kay decides to have her teeth whitened on March 1 but doesn’t pay cash at the time of service. She promises to pay the $500 whitening fee to Link by March 31.

5-9 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Other Types of Receivables Nontrade receivables: receivables that originate from sources other than customers Notes receivable: formal credit arrangements evidenced by a written debt instrument, or note

Learning Objective 2 Calculate net revenues using discounts, returns, and allowances 5-10 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-11 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Net Revenues Net revenues A company’s total revenues less any discounts, returns, and allowances Also referred to as net sales Net Revenues Sales Discounts Sales Returns and Allowances −= Sales −

5-12 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Trade Discount Reduced from the list price of a product or service Not recognized directly

5-13 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Recording Trade Discount Link’s Dental, which typically charges $500 for teeth whitening. Assume that in order to entice more customers, Dr. Link offers a 20% discount on teeth whitening to any of his regular patients.

5-14 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Sales Returns and Allowances Sales Return Seller issues a full refund Customer returns the product Sales Allowances Seller reduces the customer’s balance owed partially Customer does not return the product

5-15 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Recording Sales Allowances Dee notifies Dr. Link that another dentist is offering the same procedure for $350 Dr. Link reduces Dee’s account balance by $50

5-16 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Contra Revenue Account Opposite balance to that of its related revenue account To keep a separate record of the total revenue earned and reduction due to subsequent sales allowances

5-17 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Sales Discount Reduced from the amount to be paid by a credit customer If payment is made within a specified period of time Recognized directly Discount terms Eg: 2/10, n/30

5-18 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Recording Sales Discount Link’s Dental wants Dee to pay quickly on her teeth-whitening bill and offers her terms of 2/10, n/30. Assume Dee pays within 10 days

Part B Valuing Accounts Receivable 5-19 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 3 Record an allowance for future uncollectible accounts 5-20 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-21 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Allowance Method Allows for the possibility that some accounts will be uncollectible Companies are required to: Estimate future uncollectible accounts Record estimates in the current year Uncollectible accounts: Customers’ accounts that are no longer considered collectible Reduces assets (accounts receivable) Increases expenses (bad debt expense)

5-22 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 5.3—The Financial Statement Effects of Accounting for Future Uncollectible Accounts

5-23 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Estimating Uncollectible Accounts Percentage-of-receivables method Based on the percentage of receivables expected not to be collected Also called the balance sheet method Percentage-of-credit-sales method Also called the income statement method

5-24 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Estimating Uncollectible Accounts Bad Debt Expense: uncollectible accounts expense or provision for doubtful accounts Allowance For Uncollectible Accounts: contra asset account representing the amount of accounts receivable that we do not expect to collect

5-25 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Percentage-of-Receivables Method—Recording In 2015, Kimzey Medical Clinic bills customers $50 million. By the end of the year, $20 million remains due from customers Estimates that 30% will not be collected

5-26 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 5.5—Accounting for Uncollectible Accounts and the Accounts Receivable Portion of the Balance Sheet

Learning Objective 4 Use the aging method to estimate future uncollectible accounts 5-27 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-28 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Aging of Accounts Receivable More accurate than using single percentage Considers the age of receivables Using a higher percentage for older accounts

5-29 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Accounts Receivable Aging Schedule

Learning Objective 5 Apply the procedure to write off accounts receivable as uncollectible 5-30 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-31 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Writing Off Accounts Receivable Write-off has no effect on total amounts reported Negative effects already recorded

5-32 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Writing Off Accounts Receivable— Recording Kimzey receives notice that Bruce Easley has filed for bankruptcy Kimzey writes off Bruce’s account receivable

5-33 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Collection of Accounts Previously Written Off—Recording Bruce later pays 25% of amounts owed

5-34 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Estimating Uncollectible Accounts in the Following Year At the end of 2016, Kimzey has $30 million in receivables Estimates $8 million will not be collected

Learning Objective 6 Contrast the allowance method and direct write-off method when accounting for uncollectible accounts 5-35 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-36 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Direct Write-Off Method Records bad debt expense when uncollectible account is known Used: When uncollectible accounts are not anticipated or are immaterial When it’s not possible to reliably estimate uncollectible accounts For tax purposes only

5-37 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Illustration 5.12—Comparison of the Allowance Method and the Direct Write-off Method for Recording Uncollectible Accounts

Part C Notes Receivable 5-38 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 7 Apply the procedure to account for notes receivable, including interest calculation 5-39 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-40 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Notes Receivable Similar to accounts receivable but are more formal Evidenced by a written debt instrument, or note Classified as either current or noncurrent asset

5-41 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Recording Notes Receivable Kimzey provided $10,000 of services to Justin Payne, who is not able to pay immediately

5-42 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Recording Notes Receivable Kimzey provided $10,000 of services to Justin Payne and recorded it as a typical account receivable Justin won’t be able to pay quickly and is required to sign a six-month, 12% promissory note

5-43 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Recording Notes Receivable Justin’s books of accounts

5-44 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Interest Calculation Kimzey issued a $10,000 six-month, 12% promissory note

5-45 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Collection of Notes Receivable & Accrued Interest

5-46 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Accrued Interest

Learning Objective 8 Calculate key ratios investors use to monitor a company’s effectiveness in managing receivables 5-47 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-48 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Receivables Turnover Ratio Number of times the average accounts receivable balance is collected

5-49 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Average Collection Period Number of days the average accounts receivable balance is outstanding

Learning Objective 9 Estimate uncollectible accounts using the percentage-of-credit-sales method 5-50 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

5-51 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Percentage-of-Credit-Sales Method Estimates uncollectible accounts based on the percentage of credit sales Adjusts allowance for doubtful accounts

5-52 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Percentage-of-Credit-Sales Method—Recording Kimzey bills customers $80 million for services, with $30 million in accounts receivable Balance of the allowance account, before adjustment, is a $1 million credit For the percentage-of-receivables method, estimate for uncollectible accounts is $8 million For the percentage-of-credit-sales method, assume 12.5% of credit sales to be uncollectible

5-53 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Adjusting for Estimates of Uncollectible Accounts

5-54 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Financial Statement Effects of Estimating Uncollectible Accounts

End of Chapter Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.