Copyright © 2007 Prentice-Hall. All rights reserved 1 ReceivablesReceivables Chapter 7

Copyright © 2007 Prentice-Hall. All rights reserved 2 Objective 1 Describe the types of sales and receivables and discuss the related internal controls

Copyright © 2007 Prentice-Hall. All rights reserved 3 Types of Sales Cash Sales – debit Cash, credit Sales Revenue Bankcard Sales – debit Cash and Bankcard Discount Expense, credit Sales Revenue Debit Card Sales – debit Cash and Debit Card Discount Expense, credit Sales Revenue

Copyright © 2007 Prentice-Hall. All rights reserved 4 Types of Sales Credit Card Sales - debit Accounts Receivable and Credit Card Discount Expense, credit Sales Revenue Sales on Account – debit Accounts Receivable and credit Sales Revenue

Copyright © 2007 Prentice-Hall. All rights reserved 5 Managing the Risk of Bad Debts Establish a credit policy for new customers –Credit application –Credit check –Credit references

Copyright © 2007 Prentice-Hall. All rights reserved 6 Managing the Risk of Bad Debts Enforce credit policy for existing customers –Make credit terms and penalties clear –Follow up overdue accounts –Send reminder notices –Set absolute date when the account goes to a collection agency –Consider accepting notes receivable in lieu of accounts receivable for some customers

Copyright © 2007 Prentice-Hall. All rights reserved 7 ReceivablesReceivables Monetary Claims Arise from selling goods and services on credit and lending money

Copyright © 2007 Prentice-Hall. All rights reserved 8 ReceivablesReceivables Two major types Accounts Receivable –Current asset –Controlling account and subsidiary accounts Notes Receivable –Formal, written promise includes interest –Current or long-term asset depending on when the note matures –Currently maturing portion of long-term note

Copyright © 2007 Prentice-Hall. All rights reserved 9 Internal Controls & Receivables Separation of cash-handling and cash-accounting duties Establish credit department –Evaluates customers for credit worthiness –Pursues collection from customers

Copyright © 2007 Prentice-Hall. All rights reserved 10 Receivables & Accounting Issues Balance Sheet should report receivables at the amount the company expects to collect (net realizable value) Income Statement should report the expense associated with the failure to collect (uncollectible accounts expense)

Copyright © 2007 Prentice-Hall. All rights reserved 11 Objective 2 Use the direct write-off method to account for uncollectible receivables

Copyright © 2007 Prentice-Hall. All rights reserved 12 Direct Write-Off GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Nov9Accounts Receivable5,000 Sales5,000 Record sale on account Assume that on November 9, 2006 we sell on account, 2/10, n/30 $5,000 of merchandise. What’s the journal entry to record the sale?

Copyright © 2007 Prentice-Hall. All rights reserved 13 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Apr30 Uncollectible Accounts Expense 5,000 Accounts Receivable5,000 To write off a bad debt Direct Write-Off Method Assume that it is April 30 of the next year and the company has determined that it will not be able to collect on this account. Prepare the journal entry.

Copyright © 2007 Prentice-Hall. All rights reserved 14 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT May15Accounts Receivable5,000 Uncollectible Accounts Expense5,000 To reinstate the account 15Cash5,000 Accounts Receivable5,000 To record collection on account Direct Write-Off Method Now assume that on May 15 the same customer pays the amount due First, reinstate the Accounts Receivable, then record the collection

Copyright © 2007 Prentice-Hall. All rights reserved 15 Direct Write-Off Method Nov 9Dec 31 End of Fiscal Year Apr 30 Sale Recorded Expense Recorded Expenses should be matched with revenues in same accounting period. Bad debts arising from 2006 sales should be treated as 2006 expenses. The direct write-off method violates the matching principle. This method is acceptable only when uncollectibles are very low

Copyright © 2007 Prentice-Hall. All rights reserved 16 Objective 3 Use the allowance method to account for uncollectible receivables

Copyright © 2007 Prentice-Hall. All rights reserved 17 Allowance Method Nov 9Dec 31 End of Fiscal Year Apr 30 Prepare adjusting entry based on estimates The Allowance Method has two advantages: 1. Expenses are matched with revenues in the same accounting period 2. Accounts Receivables are reported on balance sheet at the amount of cash expected to be collected

Copyright © 2007 Prentice-Hall. All rights reserved 18 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Dec31Uncollectible Accounts Expense Allowance for Uncollectible Accounts To estimate bad debts for period Operating expense Allowance Method Contra-asset account

Copyright © 2007 Prentice-Hall. All rights reserved 19 Allowance Method Accounts Receivable – reported on balance sheet at its “net realizable value” Accounts Receivable$750,000 Allowance for Doubtful Accounts(3,500) $746,500 Gross amount Estimated uncollectible Expected to be collected

Copyright © 2007 Prentice-Hall. All rights reserved 20 Estimating Uncollectibles Two Methods –Percent of Sales – Income Statement Approach –Aging of Accounts Receivable – Balance Sheet Approach

Copyright © 2007 Prentice-Hall. All rights reserved 21 Percent of Sales Method Bad debts expense = Net Credit Sales x Bad Debt %

Copyright © 2007 Prentice-Hall. All rights reserved 22 S7-4S7-4 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Dec31Uncollectible accounts expense8,000 Allowance for uncollectible accounts8,000 Expense = (400,000 x.02) = 8,000 When you use the percentage of sales method, you are estimating the amount of the bad debts expense. Since temporary accounts start the accounting period with a -0- balance, all you have to do is take the percentage times the revenue

Copyright © 2007 Prentice-Hall. All rights reserved 23 S7-4S7-4 90,000 Accounts Receivable Bal -0- Allowance for Uncollectible Accounts 8,000 Bal 8,000 Balance Sheet (partial): Accounts receivable$90,000 Less: Allowance for uncollectible accounts(8,000) Accounts receivable, net$82,000

Copyright © 2007 Prentice-Hall. All rights reserved 24 Aging of Accounts Receivable Method 1.Accounts receivables are grouped according to age 2.Each age group has a different likelihood of being uncollectible (the older the receivable, the less likely it will be collected) 3.Add uncollectible amounts together to compute desired balance in the Allowance for Uncollectible Accounts

Copyright © 2007 Prentice-Hall. All rights reserved 25 E7-19E7-19 Age of Accounts Receivable Accounts Receivable 1-30 Days Days Days Over 90 Days $300,000$140,000$80,000$70,000$10,000 Estimated % uncollectible.5%1%6%50% Total$700$800$4,200$5,000 $10,700 Desired balance in Allowance for Uncollectible Accounts This method is called the balance sheet approach because you are estimating the balance that should be in the Allowance for Uncollectible Accounts after posting the adjusting entry

Copyright © 2007 Prentice-Hall. All rights reserved 26 E7-19E ,000 Accounts Receivable Bal 3,900 Allowance for Uncollectible Accounts 6,800 Bal 10,700 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Dec31Uncollectible accounts expense6,800 Allowance for uncollectible accounts6,800 Notice: The accounts debited and credited are the same using either the income statement approach or the balance sheet approach. It is the way the estimated amounts are computed that vary If the desired balance is $10,700 and you already have $3,900 in the account, you need to credit the account for $6,800 more Hint: With the percentage of sales method, you do not have to worry about the balance in the allowance to determine the dollar amount in the adjusting entry. With the aging of receivables method, you do need to consider the existing balance in determining the amount

Copyright © 2007 Prentice-Hall. All rights reserved 27 E7-19E ,000 Accounts Receivable Allowance for Uncollectible Accounts Balance Sheet (partial): Accounts receivable$300,000 Less: Allowance for uncollectible accounts(10,700) Accounts receivable, net$289,300 Bal 3,900 6,800 Bal 10,700

Copyright © 2007 Prentice-Hall. All rights reserved 28 Writing Off Uncollectible Accounts Horner Company uses the allowance method to account for bad debts. On Feb. 12, Horner Company determined that the $600 account receivable from L. Jay is uncollectible

Copyright © 2007 Prentice-Hall. All rights reserved 29 Writing Off Uncollectible Accounts GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Feb 12Allowance for Uncollectible Accounts600 Accounts Receivable - L. Jay600 To write off an account Under the allowance method, the expense is recognized as an adjusting entry. The balance in the Allowance account represents the amount of uncollectible receivables. When a specific account is determined to be uncollectible during the year, the allowance account needs to be reduced (debit) as does the accounts receivable (credit). This journal entry has no effect on the net receivables.

Copyright © 2007 Prentice-Hall. All rights reserved 30 Writing Off Uncollectible Accounts On Apr. 2, L. Jay pays the amount due. GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Dec31Accounts Receivable - L. Jay600 Allowance for Uncollectible Accounts600 To re-instate an account already written off 31Cash600 Accounts Receivable - L. Jay600 To record collection on account When an account already written off is collected, reverse the first entry and then record the receipt of cash. Even though Accounts Receivable is credited in the first entry and debited for the same amount in the second entry, it is important to show in your records that the account was re-established and then paid off.

Copyright © 2007 Prentice-Hall. All rights reserved 31 Objective 4 Account for notes receivable

Copyright © 2007 Prentice-Hall. All rights reserved 32 Notes Receivable A note is a written promise to pay a specific amount at a specific future date Interest - price paid by a borrower for using a lender’s money

Copyright © 2007 Prentice-Hall. All rights reserved 33 PROMISSORY NOTE ______________ _____________ Amount Date For value received, I promise to pay to the order of First National Bank __________________________________ Dollars on ______________________________ plus interest at the annual rate of 12%. ________________________ PROMISSORY NOTE ______________ _____________ Amount Date For value received, I promise to pay to the order of First National Bank __________________________________ Dollars on ______________________________ plus interest at the annual rate of 12%. ________________________ Notes Receivable $10, Ten thousand and no/ Oct. 4, 2007 January 2, 2008 Jeanette Sims Principal Payee Interest starts Maker Maturity Date Interest Rate

Copyright © 2007 Prentice-Hall. All rights reserved 34 Identifying Maturity Date Stated in terms of months - maturity date is determined by counting the months from the date of issue, and falls on same day of the month as date the note was issued Stated in terms of days - maturity date is determined by counting the days from the date of issue (do not count the day on which the note is dated, but do count the day on which it comes due)

Copyright © 2007 Prentice-Hall. All rights reserved 35 Determine the Maturity Date A 60-day note dated Oct 4, 2006 is issued. Determine the due date: Number of days on note60 Days in October31 Date of note4 Days outstanding in October27 Days remaining on note33 Days in November30 December due date3

Copyright © 2007 Prentice-Hall. All rights reserved 36 Maturity Value Principal + Interest due at maturity

Copyright © 2007 Prentice-Hall. All rights reserved 37 If the note is expressed in days, base a year on 360 days. Computing Interest Interest = Principal x Interest Rate x Time If the note is expressed in months, base a year on 12 months. Remember, the interest rate is an annual rate. If you take Principal x Interest rate, you compute the amount of interest on a one year note. This is why you must multiply by the time the note is outstanding

Copyright © 2007 Prentice-Hall. All rights reserved 38 S7-10S7-10 Note 1: $100,000 x 8% x 6/12 = $4,000 Note 2: $30,000 x 12% x 75/360 = $750 Note 3: $20,000 x 9% x 60/360 = $300 Note 4: $50,000 x 10% x 3/12 = $1,250

Copyright © 2007 Prentice-Hall. All rights reserved 39 Accounting for Notes Receivable - S7-11 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Jun12Note Receivable-C Kleuters100,000 Cash100,000 Sep10Cash102,000 Interest Revenue2,000 Note Receivable-C Kleuters100,000 First – what is the due date? Number of days on note90 Days in June30 Date of note12 Days outstanding in May18 Days remaining on note72 Days in July31 41 Days in August31 Due date in September10 Next – what is the amount of interest on this note? 100,000 x.08 x 90/360 = 2,000

Copyright © 2007 Prentice-Hall. All rights reserved 40 Accruing Interest Revenue Date of Note, May 1, 2008 End of Fiscal Year, Dec 31, 2008 Maturity Date, May 1, 2009 Prepare adjusting entry to record interest earned in 20X8 In the previous example, the note was created and matured within the same accounting period. In 7-24, the note spans two accounting periods. When a note spans two accounting periods, you need to allocate some of the interest to each period. In this example, 8 months’ interest would be accrued for 2008 (May 1-Dec 31). The other 4 months’ of interest would be recognized in 2009

Copyright © 2007 Prentice-Hall. All rights reserved 41 S7-24S7-24 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT 2008 Feb 12Cash58,800 Bankcard Discount Expense1,200 Sales Revenue60,000 May1Note Receivable - J Lim20,000 Cash20,000 Dec31Interest Receivable800 Interest Revenue800 (20,000 x.06 x 8/12)

Copyright © 2007 Prentice-Hall. All rights reserved 42 E7-24E7-24 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT 2009 May1Cash21,200 Interest Receivable800 Interest Revenue400 Note Receivable - J Lim20,000 Interest revenue = 20,000 x.06 x 4/12 Eliminate balance carried forward from last year now that you have actually received the interest payment

Copyright © 2007 Prentice-Hall. All rights reserved 43 Dishonored Notes Receivable E7-26 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT May14 Accounts Receivable - A Karsen1,200 Sales Revenue1,200 Sept1Note Receivable - A Karsen1,200 Account Receivable - A Karsen1,200 Oct30Accounts Receivable - A Karsen1,216 Note Receivable - A Karsen1,200 Interest Revenue16 When a maker of the note defaults on the note, the maturity value of the note receivable is transferred to accounts receivable because the note has expired

Copyright © 2007 Prentice-Hall. All rights reserved 44 Reporting Receivables Two approaches: Accounts receivable$5,000 Less: Allowance for uncollectible accounts(500) Accounts receivable, net$4,500 Or Accounts receivable, net of allowance for uncollectible accounts of $500$4,500

Copyright © 2007 Prentice-Hall. All rights reserved 45 Objective 5 Calculate the quick ratio and days’ sales in receivables

Copyright © 2007 Prentice-Hall. All rights reserved 46 (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities Acid-Test Ratio Also called the “quick ratio” Stringent measure of liquidity Measures entity’s ability to pay its current liabilities immediately

Copyright © 2007 Prentice-Hall. All rights reserved 47 E7-29 (a) (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities ( ) ÷ ( ) = 600 ÷ 594 = 1.01 Vision Equipment can immediately cover its current debt with the quick assets owned. This is probably adequate for most companies

Copyright © 2007 Prentice-Hall. All rights reserved 48 Days’ Sales in Receivables Also called “collection period” How many days does it take to collect the average level of receivables?

Copyright © 2007 Prentice-Hall. All rights reserved 49 One day’s sales = Net sales ÷ 365 days Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales Days’ Sales in Receivables Average net A/R = (Beginning net receivables + Ending net receivables)/2

Copyright © 2007 Prentice-Hall. All rights reserved 50 One day’s sales = $31,168 ÷ 365 days = $85.39 Days’ sales in average accounts receivable = ((2, ,424)/2) ÷ $85.39 = $2, / $85.39 = 27.5 days E7-30E7-30 Answer to part 2: Hughes’ collection period of 27.5 days is a little shorter than the company’s normal credit terms of 30 days. This is good for the company because it means the company receives cash quickly and can put its cash to work with little delay

Copyright © 2007 Prentice-Hall. All rights reserved 51 End of Chapter 7