Credit Cards and Notes Receivable Unit 8

Three parties are involved when credit cards are used in making retail sales: 1. the credit card issuer, 2. the retailer, and 3. the customer. The retailer pays the credit card issuer a percentage fee of the invoice price for its services. From an accounting standpoint, sales from bank cards (e.g., Visa and MasterCard) are treated differently than sales from non-bank cars (e.g., American Express). CREDIT CARD SALES

BANK CARD SALES Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer. These cards are issued by banks. Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller’s bank balance.

GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 31Cash Credit Card Expense ($1,000 x 3.5%) Sales To record VISA credit card sales. BANK CARD SALES Anita Ferreri purchases a number of compact discs for her restaurant from Karen Kerr Music Co. for $1,000 using her Royal Bank VISA card. The service fee that the Royal charges is 3.5 percent ,000

NON-BANK CARD SALES Sales using American Express and other non-bank cards are reported as credit sales, not cash sales. Conversion into cash does not occur until American Express remits the net amount to the seller.

NON-BANK CARD SALES Kerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 31Accounts Receivable Credit Card Expense ($500 x 5%) Sales To record American Express credit card sales

A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. The party making the promise is the maker. The party to whom payment is made is called the payee. NOTES RECEIVABLE

The basic formula for calculating interest on an interest-bearing note is: The interest rate specified on the note is an annual rate of interest. ILLUSTRATION 9-8 FORMULA FOR CALCULATING INTEREST Face Value of Note Annual Interest Rate Time in Terms of One Year Interest X X =

RECOGNIZING NOTES RECEIVABLE Wilma Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company to settle an open account. 1,000

Like accounts receivable, short-term notes receivable are reported at their net realizable value. The notes receivable allowance account is Allowance for Doubtful Notes. VALUING NOTES RECEIVABLE

HONOUR OF NOTES RECEIVABLE A note is honoured when it is paid in full at its maturity date. Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5% interest-bearing note, due in 4 months, on September 30. Wolder collects the maturity value of the note from Higley on September 30.

DISHONOUR OF NOTES RECEIVABLE A dishonoured note is a note that is not paid in full at maturity. A dishonoured note receivable is no longer negotiable. Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable.

BALANCE SHEET PRESENTATION OF RECEIVABLES Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. In the balance sheet, short-term receivables are reported within the current assets section below cash and temporary investments. Both the gross amount of receivables and the allowance for doubtful accounts should be reported.

USING THE INFORMATION IN THE FINANCIAL STATEMENTS Financial ratios are calculated to evaluate the short-term liquidity of a company. These ratios include the 1. current ratio, 2. acid test (quick) ratio, 3. receivables turnover ratio, and the 4. collection period ratio.

CURRENT RATIO CURRENT ASSETS CURRENT RATIO = ——————————— CURRENT LIABILITIES The current ratio (working capital ratio) is a widely used measure for evaluating a company’s liquidity and short-term debt-paying ability.

CASH + TEMPORARY INVESTMENTS + RECEIVABLES (NET) ACID TEST RATIO = ———————————————————————————— CURRENT LIABILITIES ACID TEST RATIO The acid test ratio (quick ratio) is a measure of a company’s short-term liquidity.

ACCOUNTS RECEIVABLE TURNOVER RATIO The ratio used to assess the liquidity of the receivables is the receivables turnover ratio. Net Credit Average Net Receivables Sales Receivables Turnover  =

COLLECTION PERIOD The collection period in days is a variant of the receivables turnover ratio and makes liquidity even more evident. The general rule is that the collection period should not exceed the credit term period. Days in Year Receivables Collection (365) Turnover Period in Days  =