8 - 1 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Accounts and Notes Receivable Chapter 8

8 - 2 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Accounts receivable Receivables Notes receivable

8 - 3 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Design internal controls for receivables. Objective 1

8 - 4 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Establishing Internal Control l What are some controls over accounts receivable? Separation of duties Separation of duties Approval for write-off Approval for write-off Control over mail receipts Control over mail receipts

8 - 5 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber The Credit Department l Companies grant credit to customers in order to increase sales. l The credit department evaluates customers who apply for credit cards.

8 - 6 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Uncollectible Accounts Expense Allowance method Direct write-off method

8 - 7 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Use the allowance method to account for uncollectibles and estimate uncollectibles by the percent of sales and aging approaches. Objective 2

8 - 8 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Methods for Estimating Uncollectible Expense Percentage of Sales Aging of Receivables

8 - 9 ©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Percentage of Sales l This is also called the income statement approach. l It is based on prior experience of the business. l It is computed as a percentage of credit sales. l It ignores the current balance of the allowance account. l The percentage used is adjusted as needed to reflect collection experience.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Percentage of Sales Example l The credit department of Ana’s Boutique estimates (based on prior experience) that 1% of net credit sales are uncollectible. l Net credit sales for the year just ended were $500,000. l What is the adjusting entry? l $500,000 × 1% = $5,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Percentage of Sales Example Dec 31, 200x Uncollectible Account Expense 5,000 Allowance for UncollectibleAccounts 5,000 Recorded expense for the year Dec 31, 200x Uncollectible Account Expense 5,000 Allowance for UncollectibleAccounts 5,000 Recorded expense for the year

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Decrease in Net Income Decrease in Net Income Decrease in net Accounts Receivable Decrease in net Accounts Receivable What is the effect of this adjusting entry? Percentage of Sales Example

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Aging of Accounts Receivable l This approach is also called the balance sheet approach because it focuses on accounts receivable. l Individual accounts receivable from specific customers are analyzed according to the length of time they remain outstanding.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Aging of Receivables Example l Assume that International Hospital’s past collection experience indicates the following: l Length of time % uncollectible 1-30 days days days days8.0

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Accounts Receivable Allowance for Uncollectible Accounts Length Amount % 1-30$1,900,0002$ 38, ,000, , , , , ,000 Total$4,100,000$143,000 Aging of Receivables Example

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Aging of Receivables Example l The allowance account is adjusted to this $143,000 balance: l Assume that the account currently has a credit balance of $100,000. l What is the adjustment?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Uncollectible Account Expense 43,000 Allowance for Uncollectible Accounts 43,000 To record allowance for uncollectibles 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? What if the account had a debit balance of $1,000? Aging of Receivables

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Allowance for Uncollectible Adjustment 1,000144,000 Adjusted balance143,000 Allowance for Uncollectible Adjustment 1,000144,000 Adjusted balance143,000 Aging of Receivables

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 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 BYTO UNCOLLECTIBLE ACCOUNT EXPENSE UNCOLLECTIBLE ACCOUNTS RECEIVABLE Amount of

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Writing Off Uncollectible Accounts l What happens when it becomes apparent that an account will not be collected? l It must be written off. l How? l Debit Allowance for Uncollectible Accounts. l Credit Accounts Receivable.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Recoveries l How is the collection of a previously written- off account recorded? l Debit Accounts Receivable (to reinstate the account). l Credit Allowance for Uncollectible Accounts. l Debit Cash. l Credit Accounts Receivable (to record the collection).

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Use the direct write-off method to account for uncollectibles. Objective 3

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Direct Write-Off Method l Using this method, an account is written off only when it becomes uncollectible. l No allowance account is created. l This method is simple to use. l The balance sheet is overstated. l The income statement is understated.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Credit Card and Bankcard Sales l These save retailers the cost of a credit department. l The retailer is required to pay a fee (called a discount) for usage.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Credit Card and Bankcard Sales l 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 Revenue100 To record a credit card sale of $100 less a 2% service charge fee Accounts Receivable (credit card)98 Credit Card Discount 2 Sales Revenue100 To record a credit card sale of $100 less a 2% service charge fee

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Debit Card Sales Using a debit card is like paying with cash. Using a debit card is like paying with cash.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Notes Receivable: an Overview l A note receivable may arise from a sale or may be given in settlement of an account receivable. l The maker pays the payee the maturity value. l The maturity value includes principal plus interest.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Promissory Note $10, Nov. 30, 2001 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100…………DOLLARS ON FEBRUARY 28, 2002 Plus interest at the annual rate of 10 percent. __________ Maker Payee Notes Receivable: an Overview

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Promissory Note $10, Nov. 30, 2001 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100…………DOLLARS ON FEBRUARY 28, 2002 Plus interest at the annual rate of 10 percent. __________ Principal Notes Receivable: an Overview

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Promissory Note $10, Nov. 30, 2001 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100…………DOLLARS ON FEBRUARY 28, 2002 Plus interest at the annual rate of 10 percent. __________ Date of issue Notes Receivable: an Overview Interest rate

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Promissory Note $10, Nov. 30, 2001 For value received, I promise to pay to the order of POPULAR BANK HOUSTON, TEXAS TEN THOUSAND AND NO/100…………DOLLARS ON FEBRUARY 28, 2002 Plus interest at the annual rate of 10 percent. __________ Notes Receivable: an Overview Maturity date

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Identifying a Note’s Maturity Date l When the period is given in days… – the maturity date is determined by counting the days from the date of issue. l The date the note was issued is omitted. l The maturity date is counted.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Principal × Rate × Time = Interest $10,000 × 10% × 90 ÷ 360 = $250 Computing Interest on a Note Compute interest on the note due to Popular Bank. Principal:$10,000 Interest:10% Time:December 1, 2001, to February 28, 2002 Compute interest on the note due to Popular Bank. Principal:$10,000 Interest:10% Time:December 1, 2001, to February 28, 2002

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Account for notes receivable. Objective 4

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Recording Notes Receivable l Assume the accounting period ended December 31. l How much interest was earned by the bank as of December 31? l $10,000 × 10% × (31 ÷ 360) = $86.11

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Recording Notes Receivable December 31 Interest Receivable86.11 Interest Revenue86.11 To accrue interest on the note December 31 Interest Receivable86.11 Interest Revenue86.11 To accrue interest on the note

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Recording Notes Receivable l How does the bank record the collection at maturity? February 28 Cash10, Note Receivable10, Interest Receivable Interest Revenue Record interest on note February 28 Cash10, Note Receivable10, Interest Receivable Interest Revenue Record interest on note

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Dishonored Notes Receivable l 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.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Report receivables on the balance sheet. Objective 5

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Reporting Receivables l Some companies report a single amount for its current receivables in the body of the balance sheet. l They use a note to the financial statements to give more details.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Use the acid-test ratio and days’ sales in receivables to evaluate a company’s financial position. Objective 6

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Acid-test ratio = (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities Acid-test ratio = (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities Acid-Test Ratio l This is a stringent test of liquidity. l It measures the entity’s ability to pay its current liabilities immediately.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Days’ Sales in Receivables l It is a measure of the time it takes to collect receivables. l A smaller number indicates a quick conversion to cash.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 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 average accounts receivable = Average net accounts receivable ÷ One day’s sales Days’ Sales in Receivables

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber End of Chapter 8