Receivables Chapter 9

Receivables Accounts receivable Notes receivable

Design internal controls Objective 1 Design internal controls for receivables.

Establishing Internal Control What are some controls over accounts receivable? Control over mail receipts Approval for write-off Separation of duties

Use the allowance method to account for uncollectibles Objective 2 Use the allowance method to account for uncollectibles and estimate uncollectibles by the percent of sales and aging approaches.

The Credit Department Companies grant credit to customers in order to increase sales. The credit department evaluates customers who apply for credit cards.

Uncollectible Accounts Expense Allowance method Direct write-off method

Methods for Estimating Uncollectible Expense Percentage of Sales Aging of Receivables

Percentage of Sales This is also called the income statement approach. It is based on prior experience of the business. It is computed as a percentage of credit sales. It ignores the current balance of the allowance account. The percentage used is adjusted as needed to reflect collection experience.

Percentage of Sales Example The credit department of Ana’s Boutique estimates (based on prior experience) that 1% of net credit sales are uncollectible. Net credit sales for the year just ended were $500,000. What is the adjusting entry? $500,000 × 1% = $5,000

Percentage of Sales Example Dec 31, 20xx Uncollectible Account Expense 5,000 Allowance for Uncollectible Accounts 5,000 Recorded expense for the year

Percentage of Sales Example What is the effect of this adjusting entry? Decrease in Net Income Decrease in net Accounts Receivable

Aging of Accounts Receivable This approach is also called the balance sheet approach because it focuses on accounts receivable. Individual accounts receivable from specific customers are analyzed according to the length of time they remain outstanding.

Aging of Receivables Example Assume that International Hospital’s past collection experience indicates the following: Length of time % uncollectible 1-30 days 2.0 31-60 days 3.0 61-90 days 5.0 90 + days 8.0

Aging of Receivables Example Length Amount % 1-30 $1,900,000 2 $ 38,000 31-60 1,000,000 3 30,000 61-90 700,000 5 35,000 90 + 500,000 8 40,000 Total $4,100,000 $143,000 Accounts Receivable Allowance for Uncollectible Accounts

Aging of Receivables Example The allowance account is adjusted to this $143,000 balance: Assume that the account currently has a credit balance of $100,000. What is the adjustment?

What if the account had a Aging of Receivables Uncollectible Account Expense 43,000 Allowance for Uncollectible Accounts 43,000 To record allowance for uncollectibles What if the account had a debit balance of $1,000?

Aging of Receivables Allowance for Uncollectible Adjustment 1,000 144,000 Adjusted balance 143,000

Comparing the Percentage of Sales and Aging Methods Allowance Method Percent of Sales Method Aging of Accounts Receivable Method Adjusts Allowance for Uncollectible Accounts Adjusts Allowance for Uncollectible Accounts BY TO Amount of Amount of UNCOLLECTIBLE ACCOUNT EXPENSE UNCOLLECTIBLE ACCOUNTS RECEIVABLE

Writing Off Uncollectible Accounts What happens when it becomes apparent that an account will not be collected? It must be written off. How? Debit Allowance for Uncollectible Accounts. Credit Accounts Receivable.

Recoveries How is the collection of a previously written- off account recorded? Debit Accounts Receivable (to reinstate the account). Credit Allowance for Uncollectible Accounts. Debit Cash. Credit Accounts Receivable (to record the collection).

Use the direct write-off method to account for uncollectibles. Objective 3 Use the direct write-off method to account for uncollectibles.

Direct Write-Off Method Using this method, an account is written off only when it becomes uncollectible. No allowance account is created. This method is simple to use. The balance sheet is overstated. The income statement is understated.

Credit Card and Bankcard Sales These save retailers the cost of a credit department. The retailer is required to pay a fee (called a discount) for usage.

Credit Card and Bankcard Sales How would Ana’s Boutique record a $100 credit card sale with a 2% service charge? Accounts Receivable (credit card) 98 Credit Card Discount 2 Sales Revenue 100 To record a credit card sale of $100 less a 2% service charge fee

Using a debit card is like Debit Card Sales Using a debit card is like paying with cash.

Notes Receivable: an Overview A note receivable may arise from a sale or may be given in settlement of an account receivable. The maker pays the payee the maturity value. The maturity value includes principal plus interest.

Notes Receivable: an Overview Promissory Note $10,000.00 Nov. 30, 2004 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100…………DOLLARS ON FEBRUARY 28, 2005 Plus interest at the annual rate of 10 percent. __________ Payee

Notes Receivable: an Overview Promissory Note $10,000.00 Nov. 30, 20x4 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100…………DOLLARS ON FEBRUARY 28, 20x5 Plus interest at the annual rate of 10 percent. __________ Principal

Notes Receivable: an Overview Promissory Note $10,000.00 Nov. 30, 20x4 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100…………DOLLARS ON FEBRUARY 28, 20x5 Plus interest at the annual rate of 10 percent. __________ Interest rate Date of issue

Notes Receivable: an Overview Promissory Note $10,000.00 Nov. 30, 20x4 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100…………DOLLARS ON FEBRUARY 28, 20x5 Plus interest at the annual rate of 10 percent. __________ Maturity date

Identifying a Note’s Maturity Date When the period is given in days… the maturity date is determined by counting the days from the date of issue. The date the note was issued is omitted. The maturity date is counted.

Computing Interest on a Note Principal × Rate × Time = Interest Compute interest on the note due to Popular Bank. Principal: $10,000 Interest: 10% Time: December 1, 20x4, to February 28, 20x5 $10,000 × 10% × 90 ÷ 360 = $250

Account for notes receivable. Objective 4 Account for notes receivable.

Recording Notes Receivable Assume the accounting period ended December 31. How much interest was earned by the bank as of December 31? $10,000 × 10% × (31 ÷ 360) = $86.11

Recording Notes Receivable December 31 Interest Receivable 86.11 Interest Revenue 86.11 To accrue interest on the note

Recording Notes Receivable How does the bank record the collection at maturity? February 28 Cash 10,250.00 Note Receivable 10,000.00 Interest Receivable 86.11 Interest Revenue 163.89 Record interest on note

Dishonored Notes Receivable If the maker of the note fails to pay the maturity value to the new payee, then the original payee legally must pay the bank the amount due.

Objective 5 Report receivables on the balance sheet.

Reporting Receivables Some companies report a single amount for its current receivables in the body of the balance sheet. They use a note to the financial statements to give more details.

Use the acid-test ratio and days’ sales in receivables to evaluate Objective 6 Use the acid-test ratio and days’ sales in receivables to evaluate a company.

Acid-Test Ratio This is a stringent test of liquidity. It measures the entity’s ability to pay its current liabilities immediately. Acid-test ratio = (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities

Days’ Sales in Receivables It is a measure of the time it takes to collect receivables. A smaller number indicates a quick conversion to cash.

Days’ Sales in Receivables One day’s sales = Net sales ÷ 365 days Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales

End of Chapter 9