Reporting and Analysing Receivables CHAPTER 8

Amounts due from individuals and companies that are expected to be collected in cashAmounts due from individuals and companies that are expected to be collected in cash Frequently classified asFrequently classified as –Accounts receivable –Notes receivable –Other receivables Types of Receivables

Accounts 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 daysNormally expected to be collected within 30 days Most significant type of claim held by companyMost significant type of claim held by company

Notes Receivable Claims for which formal instruments of credit are issued as evidence of debtClaims for which formal instruments of credit are issued as evidence of debt The credit instrument normally requires the debtor to pay interest and extends for time periods of 30 days or longerThe credit instrument normally requires the debtor to pay interest and extends for time periods of 30 days or longer Notes receivable can be current or long-termNotes receivable can be current or long-term

Other Receivables Nontrade including:Nontrade including: –Interest receivable –Loans to company officers –Advances to employees –Refundable income taxes –Recoverable sales taxes

Accounts Receivable Recorded when service is provided or at point of sale of merchandise on accountRecorded when service is provided or at point of sale of merchandise on account Accounts Receivable 100 Sales100

Allowance Method The matching principle dictates that the bad debt expense must be recorded in the period when the related revenue is earnedThe matching principle dictates that the bad debt expense must be recorded in the period when the related revenue is earned There are many acceptable methods to estimate uncollectible accountsThere are many acceptable methods to estimate uncollectible accounts

The Percentage of Receivables Method Management establishes a percentage relationship between amount of receivables and expected losses from uncollectible accountsManagement establishes a percentage relationship between amount of receivables and expected losses from uncollectible accounts –Apply percentage to total receivables –Apply percentage to receivables classified according to the length of time they have been outstanding (known as aging the accounts receivable)

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

Recording Estimated Uncollectibles The percentage of receivables method gives you the BALANCE in the Allowance account, not the amount of the adjustment. Bad Debts Expense 10,000 Allowance for Doubtful Accounts 10,000 Adj. entry 10,000 Dec. 31 Bal. 11,000 Allowance for Doubtful Accounts Jan. 1 Bal. 1,000

HAMPTON FURNITURE Balance Sheet (partial) Current Assets Cash Cash $ 14,800 Accounts receivable Accounts receivable $200,000 Less: Allowance for doubtful accounts Less: Allowance for doubtful accounts 11,000 11,000189,000 Net realizable value

Net Realizable Value Net amount expected to be collected in cashNet amount expected to be collected in cash Excludes amounts the company estimates it will not collectExcludes amounts the company estimates it will not collect Keeps receivables from being overstated on the balance sheetKeeps receivables from being overstated on the balance sheet

Write-Off of an Uncollectible Account The vice president of finance authorizes a write-off of $2,500 owed by T. O. Ebbet: Accounts Receivable Allowance for Doubtful Accounts Jan.1 Bal 227,500 Mar. 1 2,500 Mar. 1 Bal 225,000 Jan.1 Bal 11,000 Mar. 1 2,500 Mar. 1 Bal 8,500 Bad Debts Expense 10,000 Allowance for Doubtful Accounts 10,000

Recovery of an Uncollectible Account Accounts Receivable—Ebbet 2,500 Allowance for Doubtful Accounts Allowance for Doubtful Accounts2,500 Cash 2,500 Accounts Receivable Accounts Receivable2,500 Record in two separate entries

Notes Receivable Result from sale of goods and services (trade)Result from sale of goods and services (trade) Stronger legal claim to assets than accounts receivable; written promise (promissory note) to repayStronger legal claim to assets than accounts receivable; written promise (promissory note) to repay Negotiable instruments and may be transferred to another party by endorsementNegotiable instruments and may be transferred to another party by endorsement

Notes Receivable Credit instrument normally requiresCredit instrument normally requires –Payment of interest –Extends for time periods of days or longer Often accepted from customers who need to extend payment of an account receivableOften accepted from customers who need to extend payment of an account receivable Often required from high risk customersOften required from high risk customers

Notes Receivable Interest is charged as: Principal x Rate x TimeInterest is charged as: Principal x Rate x Time Interest is always quoted using annual ratesInterest is always quoted using annual rates –For example, a six-month $10,000 note at 4% means that the annual rate of interest is 4% –Interest would be $10,000 x 4% x 6/12 To record note receivable:To record note receivable: Dr. Note receivable (face value) Cr. Cash, A/R, or Sales Cr. Cash, A/R, or Sales

Managing 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 necessaryAccelerate cash receipts from receivables when necessary

Credit Risk Risk of nonpayment of account concentrated by customer or geographicallyRisk of nonpayment of account concentrated by customer or geographically Disclose concentration of credit riskDisclose concentration of credit risk

Evaluating the Receivables Balance Liquidity is measured by how quickly certain assets can be converted into cashLiquidity is measured by how quickly certain assets can be converted into cash –Receivables turnover –Average collection period

Is a measure of the liquidityIs a measure of the liquidity of receivables of receivables Receivables Turnover Receivables Turnover = Net Credit Sales Average Gross Receivables

Is the average amount of time that a receivable is outstandingIs the average amount of time that a receivable is outstanding Average Collection Period Average Collection Period = 365 days Receivables Turnover

Credit and Debit Card Sales These sales have a cost to the business, which must be recorded at the times of saleThese sales have a cost to the business, which must be recorded at the times of sale For example, the business may have to pay the credit card company 2% for each saleFor example, the business may have to pay the credit card company 2% for each sale A sale of $100 would be recorded as follows:A sale of $100 would be recorded as follows: Dr. A/R—Credit card (or Cash) 98 Dr. A/R—Credit card (or Cash) 98 Dr. Service Charge Expense 2 Dr. Service Charge Expense 2 Cr. Sales Revenue 100 Cr. Sales Revenue 100