ACTG 2110 Chapter 9 - Receivables

Management of Receivables Accounts Receivable –Often called trade receivables –Occur from ordinary course of business –Does not receive interest income –Subsidiary ledger kept containing a summary of people who owe us –Current asset –Recorded at NET REALIZABLE VALUE What we expect to collect

Management of Receivables Notes Receivable –Formal, written promissory notes –Includes interest income –Can be short or long term Other Receivables –Loans to employees –Loans to executives now forbidden in the U.S.

Management of Receivables Internal Controls –Separation of collection and accounting –Use bank lock boxes for receipt of accounts receivable payments Amounts sent directly to bank Bank may charge a collection fee Credit Department –Determines who to offer credit –Too lenient policies generate more non-collections –Too tight policies limit sales opportunities

Uncollectible Receivables Existence of uncollectible accounts Bad debt expense is recorded when accounts cannot be collected. Can use –Direct write-off method (write off actual account) –Allowance method (estimate accounts that will be bad)

Direct Write-off Method For tax purposes and when there is no material difference between the allowance method Record Bad Debt Expense and reduce Accounts Receivable for the written off account Journal entry: Bad Debt Expense200 Accts. Receivable – Jeannie Harrington 200 Often violates matching principle because write off is in a different year

Allowance Method Prepare a journal entry estimating uncollectible accounts at the end of every period Bad debt expensexxx Allowance for doubtful accounts xxx Adheres to matching principle Allowance for Doubtful Accounts is a contra-asset to reduce Accounts Receivable to its NET REALIZABLE VALUE (what we expect to collect).

Bad Debt Expense Allowance Method - GAAP Balance sheet presentation Accounts Receivable Less Allowance for Doubtful Accounts =Net realizable value Often called “NET ACCOUNTS RECEIVABLE”

Write-off of Accounts When estimation method is used, we do not know which accounts will be written off but we know some will be When the ACTUAL account is to be written off, we simply take the account out of Accounts Receivable and the Allowance Account No expense recorded now Journal entry: Allowance for Uncollectible Accts.200 Accts. Receivable – Jeannie Harrington 200

Methods of Estimating Uncollectible Accounts Income Statement Approach –Percentage of credit sales –Example: 3% of $100,000 net sales estimated to be uncollectible (3% x 100,000 = $3,000 uncollectible) –Entry: –Bad Debt Expense3,000 – Allow. for Doubtful Account3,000 –Ignore previous balance in Allowance account

Methods of Estimating Uncollectible Accounts Balance Sheet Approach –Aging of accounts method –Prepare a schedule showing how old each receivable is –Apply different percentages of uncollectibility to the different “ages” of accounts –Adjust the Allowance for Doubtful Accounts to that balance –Aging shows $3,000 to be uncollectible, Previous balance is $500 credit, Entry will be $2,500 ($3, ). –Entry: –Bad Debt Expense2,500 – Allow. for Doubtful Accounts2,500

Notes Receivable Interest bearing –Principle x interest rate x time Often have extended payment terms Formalized written agreement Can be short-term or long-term Maturity date – date note receivable is due Maturity value – face (principle) value + interest

Notes Receivable Origination of $1,000, 12%, 90 day Notes Receivable: Notes Receivable1,000 Cash1,000 Collection of Notes Receivable: Cash 1,030 Notes Receivable1,000 Interest Revenue 30 (1000 x.12 x 90/360) Must accrue interest income when time passes and note is still not paid

Financial Analysis and Interpretation Accounts Receivable Turnover –Tells us the number of times we collect our receivables in a period –Good to have a high A/R turnover –Calculation: Net credit sales – Average accounts receivable –Average collection period: 365 – Accts. Receivable turnover –You want a short collection period