Financial Accounting: Tools for Business Decision Making, 3rd Ed. Kimmel, Weygandt, Kieso ELS

Chapter 8

Chapter 8 Reporting and Analyzing Receivables PowerPoint Slides After studying Chapter 8, you should be able to: Identify the different types of receivables. Explain how accounts receivable are recognized in the accounts. Describe the methods used to account for bad debts. Compute the interest on notes receivable. Describe the entries to record the disposition of notes receivable. 1

Chapter 8 Reporting and Analyzing Receivables PowerPoint Slides After studying Chapter 8, you should be able to: Explain the statement presentation of receivables. Describe the principles of sound accounts receivable management. Identify ratios to analyze a company's receivables. Describe methods to accelerate the receipt of cash from receivables. 2

PowerPoint Slides Receivables... Amounts due from individuals and companies - expected to be collected in cash. Frequently classified as: Accounts receivable Notes receivable Other receivables 3

Receivables Differ Depending On... PowerPoint Slides Receivables Differ Depending On... Industry Time of year Whether the company extends long-term financing Credit policies 3

Accounts Receivable... Amounts owed by customers on account. PowerPoint Slides Accounts Receivable... Amounts owed by customers on account. Result from the sale of goods/services. Expected to be collected within 30-60 days. Most significant type of claim held by company. Often called trade receivables. 4

Problems with Accounts Receivable PowerPoint Slides Problems with Accounts Receivable Recognizing accounts receivable. Valuing accounts receivable. 4

Accounts Receivables... Are reduced as a result of: Sales discounts PowerPoint Slides Accounts Receivables... Are reduced as a result of: Sales discounts Sales returns and allowances 4

PowerPoint Slides Notes Receivable... Represent claims for which formal instruments of credit are issued as evidence of debt. 2004 5

Other Receivables Nontrade including: interest receivable PowerPoint Slides Other Receivables Nontrade including: interest receivable loans to company officers advances to employees income taxes refundable 7

Accounts Receivable... PowerPoint Slides Are recorded when service is provided or at point of sale of merchandise on account. Accounts Receivable 100 Sales 100 8

Bad Debts Expense... Is an expense to record estimated uncollectible receivables. Keeps expenses from being understated on the income statement and accounts receivables from being overstated on the balance sheet.

2 Methods for Accounting for Uncollectible Accounts PowerPoint Slides The Direct Write-off Method The Allowance Method 11

Direct Write-off Method PowerPoint Slides Direct Write-off Method Bad debt losses are not estimated. No allowance account is used. Accounts are written off when determined uncollectible as follows: Bad Debts Expense 200 Accounts Receivable--M. E. Doran 200 Bad debt expense will show only actual losses. Accounts receivable will be reported at gross amount. 14

Direct Write-off Method Issue PowerPoint Slides Direct Write-off Method Issue No attempt is made to match bad debts expense to sales revenue. 13

PowerPoint Slides Allowance Method Uncollectible accounts receivable are estimated and matched against sales in the same accounting period in which the sales occurred. Uncollectible accounts receivable may be estimated using: Percentage of sales Aging of accounts receivable 12

Recording Estimated Uncollectibles PowerPoint Slides Recording Estimated Uncollectibles Hampton Furniture has credit sales of $1,200,000, of which $200,000 remains uncollected. The credit manager estimates $12,000 will prove uncollectible. Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000 13

Recording Estimated Uncollectibles PowerPoint Slides Recording Estimated Uncollectibles Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000 Accounts Receivable Allowance for Doubtful Accounts Jan 1 Bal 200,000 Jan 1 Bal 12,000 13

Keeps receivables from being overstated PowerPoint Slides Cash (Net) Realizable Value... Is the net amount expected to be collected in cash. Excludes amounts the company estimates it will not collect. Keeps receivables from being overstated on the balance sheet. 9

Balance Sheet (partial) HAMPTON FURNITURE Balance Sheet (partial) Current assets Cash $ 14,800 Accounts receivable $200,000 Less: Allowance for doubtful accounts 12,000 188,000 Cash (net) Realizable Value

Balance Sheet (partial) HAMPTON FURNITURE Balance Sheet (partial) Current assets Cash $ 14,800 Accounts receivable $200,000 Less: Allowance for doubtful accounts 12,000 188,000 Merchandise Inventory 310,000 Prepaid Expense 25,000 Total current assets $537,800

Write-off of an Uncollectible Account PowerPoint Slides Write-off of an Uncollectible Account The vice president of finance authorizes a write-off of $500 owed by R.A. Ware. Allowance for Doubtful Accounts 500 Accounts Receivable-Ware 500 13

Write-off of an Uncollectible Account PowerPoint Slides Write-off of an Uncollectible Account Allowance for Doubtful Accounts 500 Accounts Receivable-Ware 500 Accounts Receivable Allowance for Doubtful Accounts Jan 1 Bal 200,000 Mar 1 500 Mar 1 Bal 199,500 Jan 1 Bal 12,000 Mar 1 Bal 11,500 13

Before Write-off After Write-off Current assets Cash $ 14,800 Accounts receivable $200,000 Less: Allowance for doubtful accounts 12,000 188,000 Cash Realizable Value After Write-off Current assets Cash $ 14,800 Accounts receivable $199,500 Less: Allowance for doubtful accounts 11,500 188,000 Cash Realizable Value

Recovery of an Uncollectible Account PowerPoint Slides Recovery of an Uncollectible Account Accounts Receivable-Ware 500 Allowance for Doubtful Accounts 500 Cash 500 Accounts Receivable 500 13

Percentage of Receivables... PowerPoint Slides Percentage of Receivables... Management establishes a percentage relationship between the amount of receivables and the expected losses from uncollectible accounts. 12

Aging of Accounts Receivable PowerPoint Slides Aging of Accounts Receivable The analysis of customer balances by the length of time they have been unpaid. The longer a debt is outstanding the less likely it is to be paid. 12

PowerPoint Slides Trade Receivables... Notes and accounts receivables that result from sales transactions. 5

PowerPoint Slides Notes Receivable... Credit which is extended by use of a formal instrument. 6

Notes Receivable... Credit instrument normally requires: PowerPoint Slides Notes Receivable... Credit instrument normally requires: payment of interest extends for time periods of 60-90 days or longer. 5

PowerPoint Slides Notes Receivable... Are often accepted from customers who need to extend payment of an account receivable. Are often required from high-risk customers. 15

PowerPoint Slides Notes Receivable... Represent claims for which formal instruments of credit are issued as evidence of debt. 2004 5

PowerPoint Slides Maker Is the party in a promissory note who is making the promise to pay. Payee Payee Is the party to whom payment of a promissory note is to be made. Is the party to whom payment of a promissory note is to be made. 18

Formula for Interest PowerPoint Slides 18

PowerPoint Slides Interest rate specified on a note is an annual rate of interest. Prorate for shorter times periods. 1,000 x .12 x 12 months/12months 1,000 x .12 x 1 month/12months 1,000 x .12 x 3 months/12months 1,000 x .12 x 6 months/12months 1,000 x .12 x 9 months/12months 18

Interest rate specified on a note is an annual rate of interest. PowerPoint Slides Interest rate specified on a note is an annual rate of interest. Time factor is often divided by 360 days 1,000 x .12 x 360 days/360 days 1,000 x .12 x 27 days/360 days 1,000 x .12 x 46 days/360 days 1,000 x .12 x 162 days/360 days 1,000 x .12 x 265 days/360 days 18

Notes Receivable... are recorded at face value. PowerPoint Slides are recorded at face value. are reported at cash (net) realizable value. are honored when paid in full at maturity. are dishonored when not paid in full at maturity. 19

Notes Receivable... PowerPoint Slides Interest revenue is recorded when the note is paid. If interim financial statements are prepared, interest on notes receivable is accrued. 19

Notes Receivable... PowerPoint Slides Each type of receivables should be identified in the balance sheet or in the notes to the financial statements. Short-term receivables are reported in the current asset section of the balance sheet below short-term investments. The gross amount of receivables and the allowance for doubtful accounts should be reported. 19

Notes Receivable... PowerPoint Slides Notes receivable are listed before accounts receivable because notes are more easily converted to cash. Bad debts expense is reported as a selling expense in the income statement. Interest revenue is shown under other revenues and gains in the nonoperating section of the income statement. 19

Managing Receivables Determine to whom to extend credit. PowerPoint Slides Managing Receivables Determine to whom to extend credit. Establish a payment period. Monitor collections. Evaluate receivables balance. Accelerate cash receipts from receivables when necessary. 24

PowerPoint Slides Extending Credit Risky customers might be required to provide letters of credit or bank guarantees. Risky customers might be required to pay cash on delivery (COD). Ask potential customers for references from banks and suppliers and check the references. Periodically check financial health of continuing customers. 25

Payment Period PowerPoint Slides Determine a required payment period and communicate that policy to customers. Make sure company's payment period is consistent with that of competitors. 26

Monitoring Collections PowerPoint Slides Monitoring Collections Calculate company’s credit risk ratio. Prepare accounts receivable aging schedule at least monthly. Pursue problem accounts with: phone calls letters legal action if necessary. 27

Concentration of Credit Risk PowerPoint Slides Concentration of Credit Risk Is there a threat of nonpayment from a single customer or class of customers that could adversely affect the financial health of the company. 27

Evaluating the Receivables Balance PowerPoint Slides Liquidity is measured by how quickly certain assets can be converted into cash. The receivables turnover ratio measures the number of times, on average, receivables are collected during the period. 28

Receivables Turnover Ratio= PowerPoint Slides Net Credit Sales Average Net Receivables Is a measure of the liquidity of receivables. 28

Average Collection Period= PowerPoint Slides 365 days Receivables Turnover Ratio Is the average amount of time that a receivable is outstanding 28

Accelerating Cash Receipts PowerPoint Slides Waiting for the normal collection process cost money. 30

Accelerating Cash Receipts PowerPoint Slides A bird in the hand is worth two in the bush. 30

Companies Sell Receivables PowerPoint Slides Companies Sell Receivables They get more sales if they provide financing to customers. General Motors Acceptance Corporation Ford Motor Credit Corporation They may be the only reasonable source of cash. Billing and collection are often time-consuming and costly. 30

PowerPoint Slides Factor... Is a finance company or bank that buys receivables from businesses for a fee and then collects payments directly from the customers. 32

Expense Associated with Selling Receivables PowerPoint Slides If a company usually sells its receivables, the service charge expense is recorded as a selling expense. However, if receivables are sold infrequently the fee may be reported under other expenses and losses in the income statement. 33

PowerPoint Slides Credit Card A common type of credit card is a national credit card such as: Visa Master Card American Express 34

PowerPoint Slides Credit Card Three parties are involved when national credit cards are used in making retail sales: the credit card issuer the retailer the customer 35

PowerPoint Slides Bank Credit Card Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer. Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller's bank balance. 36

Advantages of Credit Cards to the Retailer

Advantages of Credit Cards to the Retailer

Advantages of Credit Cards to the Retailer

Advantages of Credit Cards to the Retailer