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Chapter 8 Receivables Accounting, 21st Edition Warren Reeve Fess © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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After studying this chapter, you should be able to: Objectives 1. List the common classifications of receivables. 2. Summarize and provide examples of internal control procedures that apply to receivables. 3. Describe the nature of and the accounting for uncollectible receivables. 4. Journalize the entries for the allowance method of accounting for uncollectibles, and estimate uncollectible receivables based on sales and on an analysis of receivables. After studying this chapter, you should be able to:

Objectives 5. Journalize the entries for the direct write-off of uncollectible receivables. 6. Describe the nature and characteristics of promissory notes. 7. Journalize the entries for notes receivable transactions. 8. Prepare the Current Assets presentation of receivables on the balance sheet. 9. Compute and interpret the accounts receivable turnover and the number of days’ sales in receivables.

Classification of Receivables Accounts Receivable—used for selling merchandise or services on credit, and normally expected to be collected in a relatively short period. Notes Receivable—used to grant credit on the basis of a formal instrument of credit, called a promissory note. Other Receivables—include interest receivable, taxes receivable, and receivables from officers and employees.

Separating the Receivable Functions Customer Credit Info. Credit Approval Collections Sales Acctg. Info Goods or services Invoice Acctg. Info. Accounting

Uncollectible Receivables Companies often sell their receivables to other companies. This transaction is called factoring the receivables, and the buyer of the receivables is called a factor.

Uncollectible Receivables The Allowance Method This method is consistent with the matching principle. Management makes an estimate each year of the portion of accounts receivable that may not be collectible. Uncollectible Accounts Expense is debited and Allowance for Doubtful Accounts is credited. Actual accounts that prove to be uncollectible are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable.

The Allowance Method On December 31, Cynthia Richards estimates that a total of $4,000 of the $105,000 balance in her company’s Accounts Receivable will eventually be uncollectible. Adjusting Entry Dec. 31 Uncollectible Accounts Expense 4 000 00 Allowance for Doubtful Accounts 4 000 00

The Allowance Method The net amount that is expected to be collected, $101,000 ($105,000 – $4,000), is called the net realizable value (NRV). The adjusting entry reduces receivables to the NRV and matches uncollectible expenses with revenues.

Allowance for Doubtful Accounts The Allowance Method Adjusting Entry The adjusting entry fills the bucket. Allowance for Doubtful Accounts

Allowance for DOUBTFUL accounts The Allowance Method Writing off accounts empties the bucket. Allowance for DOUBTFUL accounts

The Allowance Method Jan. 21 Allowance for Doubtful Accounts 610 00 Accounts Receivable—John Parker 610 00 To write off the uncollectible account. On January 21, John Parker’s account totaling $610 is considered to be uncollectible.

On June 10, the written-off account is collected. The Allowance Method Jun. 10 Accounts Receivable—John Parker 610 00 Allowance for Doubtful Accounts 610 00 To reinstate the account written off on Jan. 21. On June 10, the written-off account is collected. An entry is made to reinstate John Parker’s account.

A second entry is made to record receipt of the cash. The Allowance Method Jun. 10 Cash 610 00 Accounts Receivable—John Parker 610 00 To record collection on account. A second entry is made to record receipt of the cash.

Estimating Uncollectible Accounts Expense The Allowance Method Estimating Uncollectible Accounts Expense The allowance method uses two ways to estimate the amount debited to Uncollectible Accounts Expense. 1. Estimate based on a percentage of sales. If credit sales for the period are $300,000 and it is estimated that 1% will be uncollectible, the Uncollectible Accounts Expense is $3,000.

Based on a Percentage of Sales The Allowance Method Adjusting Entry Dec. 31 Uncollectible Accounts Expense 3 000 00 Allowance for Doubtful Accounts 3 000 00 Based on a Percentage of Sales

Estimating Uncollectible Accounts Expense The Allowance Method Estimating Uncollectible Accounts Expense The allowance method uses two ways to estimate the amount debited to Uncollectible Accounts Expense. 2. Estimate based on analysis of receivables. If it is estimated that $3,390 of the receivables will be uncollectible and the Allowance for Uncollectible Accounts currently has a balance of $510, the Uncollectible Accounts Expense must be debited for $2,880 ($3,390 – $510).

Based on an Analysis of Receivables The Allowance Method Adjusting Entry Dec. 31 Uncollectible Accounts Expense 2 880 00 Allowance for Doubtful Accounts 2 880 00 Based on an Analysis of Receivables

Total accounts receivable shown by age. Accounts Receivable Aging and Uncollectibles Not Days Past Due Past over Customer Balance Due 1-30 31-60 61-90 91-180 181-365 365 Ashby & Co. $ 150 $ 150 B. T. Barr 610 $ 350 $260 Brock Co. 470 $ 470 Saxon Woods 160 160 Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300 Total accounts receivable shown by age.

Accounts Receivable Aging and Uncollectibles Not Days Past Due Past over Customer Balance Due 1-30 31-60 61-90 91-180 181-365 365 Ashby & Co. $ 150 $ 150 B. T. Barr 610 $ 350 $260 Brock Co. 470 $ 470 Saxon Woods 160 160 Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300 Uncollectibles PERCENT 2% 5% 10% 20% 30% 50% 80% Uncollectible percentages based on experience and industry averages.

Accounts Receivable Aging and Uncollectibles Not Days Past Due Past over Customer Balance Due 1-30 31-60 61-90 91-180 181-365 365 Ashby & Co. $ 150 $ 150 B. T. Barr 610 $ 350 $260 Brock Co. 470 $ 470 Saxon Woods 160 160 Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300 Uncollectibles PERCENT 2% 5% 10% 20% 30% 50% 80% AMOUNT $3,390 = $1,500 $200 $310 $380 $360 $400 $240

Year-End Adjustment for Uncollectibles General Ledger Balance Sheet Accounts Receivable Accounts receivable $86,300 Less allowance for doubtful accounts 3,390 Net realizable value $82,910 A 86,300 C Allowance for Doubtful Accts. 510 A 2,880 B Balances before adjustment A 3,390 C Uncollectible Accts. Expense Year-end adjustment: $3,390 – $510 = $2,880 B 2,880 B Balance after adjustment C

Accounting for Uncollectible Accounts Receivable The Direct Write-Off Method This method is not consistent with the matching principle. Accounts that prove to be uncollectible are written off in the year they become worthless. Uncollectible Accounts Expense is debited and Accounts Receivable is credited for each such transaction.

The Direct Write-Off Method May 10 Uncollectible Accounts Expense 420 00 Accounts Receivable—D. L. Ross 420 00 To write off an uncollectible account. On May 10, D. L. Ross’ account was determined to be uncollectible. The $420 balance is written off the books.

The Direct Write-Off Method Nov. 1 Accounts Receivable—D. L. Ross 420 00 Uncollectible Accounts Expense 420 00 To reinstate account written off on May 10. 1st Entry In November, D. L. Ross remits a check for $420 in payment of his account.

A second entry is needed to record receipt of the cash. The Direct Write-Off Method Nov. 1 Cash 420 00 Accounts Receivable—D. L. Ross 420 00 To record collection on account. 2nd Entry A second entry is needed to record receipt of the cash.

Notes Receivable Payee Maker H. B. Lane $_____________ 2,500.00 Fresno, California______________20___ March 16 06 ________________ _AFTER DATE _______ PROMISE TO PAY TO Ninety days We THE ORDER OF ____________________________________________ Judson Company Two thousand five hundred 00/100--------------------------- _________________________________________________DOLLARS Maker PAYABLE AT ______________________________________________ City National Bank VALUE RECEIVED WITH INTEREST AT ____ 10% NO. _______ DUE___________________ 14 June 14, 2006 H. B. Lane TREASURER, WILLIARD COMPANY

Notes Receivable A promissory note is a written document containing a promise to pay: a specific amount of money (principal) to a specific person or company (payee) at a specific place on a specific date or upon demand plus interest at a specific percentage of the principal (face) amount per year

Let’s determine the due date for a 90-day note dated March 16. Notes Receivable Let’s determine the due date for a 90-day note dated March 16. The date a note is to be paid is called the due date. It is also referred to as the maturity date.

Notes Receivable Answer: June 14 Total days in note 90 days Number of days in March 31 Issue date of note March 16 Remaining days in March –15 days 75 days Number of days in April –30 days 45 days Number of days in May –31 days Residual days in June 14 days Answer: June 14

Notes Receivable The amount that is due at the maturity or due date is called the maturity value.

Notes Receivable Received a $6,000, 12%, 30-day note dated November 21, 2006 in settlement of the account of W. A Bunn Co.

Principal x Rate x Time = Interest Maturity Value Calculation Notes Receivable Interest Calculation Principal x Rate x Time = Interest $6,000 x 12% x 30/360 = $60.00 Maturity Value Calculation Principal + Interest = Maturity Value $6,000 + $60.00 = $6,060.00

Accounting for Notes Receivable Nov. 21 Notes Receivable 6 000 00 Sales 6 000 00 Received 30-day, 12% note dated November 21, 2006. A $6,000 30-day, 12% note dated November 21 is received from W. A Bunn Company in exchange for merchandise.

Accounting for Notes Receivable Dec. 21 Cash 6 060 00 Notes Receivable 6 000 00 Interest Revenue 60 00 Received principal and interest on matured note. On December 21, when the note matures, the firm receives $6060 from W. A. Bunn Company ($6,000 plus $60 interest).

Accounting for Notes Receivable Dec. 21 Accounts Receivable—Bunn Co. 6 060 00 Notes Receivable 6 000 00 Interest Revenue 60 00 To record dishonored note and interest. If W. A. Bunn Company fails to pay the note on the due date, it is considered a dishonored note receivable. The note and interest are transferred to the customer’s account.

Accounting for Notes Receivable Dec. 1 Notes Receivable 4 000 00 Accounts Receivable—Crawford Company 4 000 00 Received note in settlement of account. A 90-day, 12% note dated December 1, 2006, is received from Crawford Company to settle its account, which has a balance of $4,000.

Accounting for Notes Receivable Dec. 31 Interest Receivable 40 00 Interest Revenue 40 00 Adjusting entry for accrued interest. Assuming that the accounting period ends on December 31, an adjusting entry is required to record the accrued interest of $40 ($4,000 x 0.12 x 30/360).

Accounting for Notes Receivable Mar. 1 Cash 4 120 00 Notes Receivable 4 000 00 Interest Receivable 40 00 Interest Revenue 80 00 $4,000 x 0.12 x 60/360 Received payment on note and interest. On March 1, 2004, $4,120 is received for the note ($4,000) and interest ($120).

Receivables on the Balance Sheet

Crabtree Co. Balance Sheet December 31, 2006 Assets Current assets: Cash $119,500 Notes receivable 250,000 Accounts receivable $445,000 Less allowance for doubtful accounts 15,000 430,000 Interest receivable 14,500 Merchandise inventory 714,000 Highlighted items are receivables

Financial Analysis and Interpretation Accounts Receivable Turnover Net sales Average accounts receivable

Accounts Receivable Turnover 2006 2005 Net sales on account $36,000,000 $32,500,000 Accounts receivable (net): Beginning of year $ 1,080,000 $1,050,000 End of year 1,220,000 1,080,000 Total $2,300,000 $2,130,000 Average $1,150,000 $1,115,000 Accounts receivable turnover 31.3 times 29.1 times $36,000,000 $1,150,000 $32,500,000 $1,115,000 Use: To assess the efficiency in collecting receivables and in the management of credit.

Number of Days’ Sales in Receivables Accounts receivable, end of year Average daily sales Accounts receivable, end of year Average daily sales on account $1,220,000 ($36,000,000 ÷ 365 days) =12.4 days Use: To assess the efficiency in collecting receivables and in the management of credit.

Chapter 8 The End