Accounting for Receivables Chapter Seven McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Accounts Receivable and Notes Receivable When a company allows customers to “buy now and pay later,” the company’s right to collect cash in the future is called accounts receivable. Individually, these receivables are typically small and are payable within 30 days. When a longer credit term is needed, or when the receivable is large, the company usually requires the customer to issue a note that specifies interest and other credit terms. The company then records a note receivable. 7-1

Credit Terms and Bad Debts Some customers may be unwilling or unable to pay their accounts receivable. Because we do not want to overstate assets, we must show accounts receivable at its net realizable value on the balance sheet. The net realizable value is the gross amount of the receivables less some estimated allowance for doubtful accounts. Multiplying the service revenue by the percentage estimate of uncollectible accounts is commonly called the percent of revenue method of estimating uncollectible accounts expense. 7-2

Recognizing Uncollectible Accounts Expense Based upon past experience, assume that a company estimates that $75 of its current accounts receivable balance will eventually prove to be uncollectible. 7-3

Financial Statements Panel C Financial Statements for

Aging Schedule 7-5

Balance Required under the Percent of Receivables Method 7-6

Computing Uncollectible Accounts Expense 7-7

Direct Write-Off Method Recall that in 2013, ATC recognized $14,000 of revenue on account. No entry will be made at year-end to estimate uncollectible accounts expense if ATC believes that amount will be immaterial. 7-8

Direct Write-Off Method – Writing Off an Account During 2014, the company determines that a customer who owes $70 is unable to pay. 7-9

Direct Write-Off Method – Recovery of a Written-Off Account Also in 2014, ATC collects $10 from an account that had been previously written off. ATC first reinstates the account by reversing the write-off. 7-10

Direct Write-Off Method – Recovery of a Written-Off Account Once the account is reinstated, the event is recorded the same as the collection of any other receivable. 7-11

Accounting for a Promissory Note 7-12

Notes Receivable Event 1 Loan of Money On November 1, 2013, ATS loans $15,000 cash to Stanford Cummings. Cummings issues ATS a note promising to repay the loan, with interest, in one year. 7-13

Interest Revenue Event 2 Recognition of Interest Revenue At the end of 2013, ATS must accrue interest on its note receivable. $15,000 × 6% × 2/12 = $150 interest revenue 7-14

Collection of a Note Receivable Event 3 Collection of Principal and Interest On October 31, 2014, ATS collects the principal and interest due on the note receivable. ATS first recognizes interest revenue for the 10 months of $15,000 × 6% × 10/12 = $750 interest revenue 7-15

Collection of a Note Receivable Event 3 Collection of Principal and Interest Now that the entire $900 of interest receivable has been accrued, ATS records the collection of $15,900 in principal and interest on the note. 7-16

Credit Card Sales Rather than maintaining a credit-granting department, many companies find it cost beneficial to accept credit cards. The credit card company deducts a fee, usually between 2% and 8%, from the gross amount of the sales, and pays the merchant the net balance (gross sales less credit card fee). 7-17

Credit Card Sales Event 1 Recording a Credit Card Sale ATS accepts a credit card in payment for services of $1,000. The credit card company charges a fee of 5% of the transaction. 7-18

Credit Card Sales Event 2 Collection of a Credit Card Receivable ATS collects the full amount due from the credit card company. 7-19

Accounts Receivable Turnover Accounts Receivable Turnover Ratio Sales Accounts Receivable = The longer it takes to collect accounts receivable, the greater the opportunity cost of lost income. 7-20

Days to Collect Receivable This ratio often helps simplify the issues surrounding the collections of accounts receivable. Average Number of Days to Collect Accounts Receivable = 365 Accounts Receivable Turnover Ratio 7-21

End of Chapter Seven 7-22