1. 8-1

2. 8-2 Reporting and Analyzing Receivables Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition 8

3. 8-3 Describe how companies value accounts receivable and record their disposition. CHAPTER OUTLINE Explain how companies recognize accounts receivable. 1 2 LEARNING OBJECTIVES Explain how companies recognize, value, and dispose of notes receivable. 3 Describe the statement presentation of receivables and the principles of receivables management. 4

4. 8-4 Amounts due from individuals and companies that are expected to be collected in cash. Amounts customers owe on account that result from the sale of goods and services. Accounts Receivable Written promise (formal instrument) for amount to be received. Also called trade receivables. Nontrade receivables such as interest, loans to officers, advances to employees, and income taxes refundable. Notes Receivable Other Receivables LEARNING OBJECTIVE Explain how companies recognize accounts receivable. 1 LO 1

5. 8-5  Service organization records a receivable when it performs service on account.  Merchandiser records accounts receivable at the point of sale of merchandise on account.  Seller may offer a discount to encourage early payment.  Buyer might return goods found to be unacceptable. ► Sales returns reduce receivables. RECOGNIZING ACCOUNTS RECEIVABLE LO 1

6. 8-6 Illustration: Assume that Jordache Co. on July 1, 2017, sells merchandise on account to Polo Company for $1,000 terms 2/10, n/30. Prepare the journal entry to record this transaction on the books of Jordache Co. Accounts Receivable1,000Jul. 1 Sales Revenue1,000 RECOGNIZING ACCOUNTS RECEIVABLE LO 1

7. 8-7 Illustration: On July 5, Polo returns merchandise worth $100 to Jordache Co. Sales Returns and Allowances100Jul. 5 Accounts Receivable100 Illustration: On July 11, Jordache receives payment from Polo Company for the balance due. Cash ($900 - $18)882Jul. 11 Sales Discounts ($900 x.02)18 Accounts Receivable900 RECOGNIZING ACCOUNTS RECEIVABLE LO 1

8. 8-8 Interest Revenue4.50 Illustration: Some retailers issue their own credit cards. Assume that you use your JCPenney Company credit card to purchase clothing with a sales price of $300. Accounts Receivable300 Sales Revenue300 Assuming that you owe $300 at the end of the month, and JCPenney charges 1.5% per month on the balance due Accounts Receivable4.50 RECOGNIZING ACCOUNTS RECEIVABLE LO 1

9. 8-9 Recognizing Accounts Receivable DO IT! 1 LO 1 On May 1, Wilton sold merchandise on account to Bates for $50,000 terms 3/15, net 45. On May 4, Bates returns merchandise with a sales price of $2,000. On May 16, Wilton receives payment from Bates for the balance due. Prepare journal entries to record the May transactions on Wilton’s books. (Ignore cost of goods sold entries.) Accounts Receivable—Bates 50,000 Sales Revenue 50,000 May 1 Sales Returns and Allowances 2,000 Accounts Receivable—Bates 2,000 Cash ($48,000 - $1,440) 46,560 Sales Discounts ($48,000 x.03) 1,440 Accounts Receivable—Bates 48,000 4 16

10. 8-10 VALUING ACCOUNTS RECEIVABLE  Current asset.  Valuation (net realizable value). Uncollectible Accounts Receivable  Sales on account raise the possibility of accounts not being collected.  Seller records losses that result from extending credit as Bad Debt Expense. LEARNING OBJECTIVE Describe how companies value accounts receivable and record their disposition. 2 LO 2

11. 8-11 Allowance Method Losses are estimated:   Better matching.   Receivable stated at net realizable value.   Required by GAAP. Methods of Accounting for Uncollectible Accounts Direct Write-Off Theoretically undesirable:  No matching.  Receivable not stated at net realizable value.  Not acceptable for financial reporting. VALUING ACCOUNTS RECEIVABLE LO 2

12. 8-12 1.NOT allowed by GAAP. 2.Company records revenue when earned and nothing else until it is determined a known account will not be collected. 3.Bad debt expense will show only actual losses from uncollectibles. 4.Companies debit Bad Debts Expense and credit Accounts Receivable at the time the specific account is written off as uncollectible. Direct Write-Off Method for Uncollectible Accounts LO 2

13. 8-13 Illustration: Assume that Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. Warden’s entry is: Bad Debt Expense 200 Accounts Receivable—M. E. Doran 200 Theoretically undesirable:  No matching.  Receivable not stated at cash realizable value.  Not acceptable for financial reporting. Direct Write-Off Method for Uncollectible Accounts LO 2

14. 8-14 1.Companies estimate uncollectible accounts receivable. 2.Debit Bad Debt Expense and credit Allowance for Doubtful Accounts (a contra-asset account). 3.Companies debit Allowance for Doubtful Accounts and credit Accounts Receivable at the time the specific account is written off as uncollectible. Allowance Method for Uncollectible Accounts LO 2

15. 8-15 Illustration: Hampson Furniture has credit sales of $1,200,000 in 2017, of which $200,000 remains uncollected at December 31. The credit manager estimates that $12,000 of these sales will prove uncollectible. Bad Debt Expense 12,000 Allowance for Doubtful Accounts 12,000 Dec. 31 RECORDING ESTIMATED UNCOLLECTIBLES Allowance Method for Uncollectibles LO 2

16. 8-16 Illustration 8-3 Presentation of allowance for doubtful accounts Allowance Method for Uncollectibles LO 2

17. 8-17 Illustration: The vice-president of finance of Hampson Furniture on March 1, 2018, authorizes a write-off of the $500 balance owed by R. A. Ware. The entry to record the write-off is: Allowance for Doubtful Accounts 500 Accounts Receivable—R. A. Ware 500 Mar. 1 WRITE-OFF OF AN UNCOLLECTIBLE ACCOUNT Allowance Method for Uncollectibles ILLUSTRATION 8-4 General ledger balances after write-off LO 2

18. 8-18 Accounts Receivable—R. A. Ware 500 Allowance for Doubtful Accounts 500 1 July 1 Illustration: On July 1, R. A. Ware pays the $500 amount that Hampson Furniture had written off on March 1. Hampson makes these entries: RECOVERY OF AN UNCOLLECTIBLE ACCOUNT Cash500 Accounts Receivable—R. A. Ware 500 ▼ HELPFUL HINT Like the write-off, a recovery does not involve the income statement. Allowance Method for Uncollectibles LO 2

19. 8-19 ILLUSTRATION 8-6 Nike’s allowance method disclosure ESTIMATING THE ALLOWANCE Allowance Method for Uncollectibles LO 2

20. 8-20 Under the percentage-of- receivables basis, management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts. ESTIMATING THE ALLOWANCE Amount of bad debt expense that should be recorded in the adjusting entry is the difference between the required balance and the existing balance in the allowance account. LO 2

21. 8-21 Illustration 8-7 Aging schedule Aging of Accounts Receivable ESTIMATING THE ALLOWANCE ▼ HELPFUL HINT The percentage-of- receivables basis may use only a single percentage rate. LO 2

22. 8-22 Illustration: Assume the unadjusted trial balance shows Allowance for Doubtful Accounts with a credit balance of $528. Prepare the adjusting entry assuming $2,228 is the estimate of uncollectible receivables from the aging schedule. Bad Debt Expense 1,700 Dec. 31 Allowance for Doubtful Accounts 1,700 Illustration 8-8 Bad debts accounts after posting ESTIMATING THE ALLOWANCE LO 2

23. 8-23 Brule Co. has been in business five years. The unadjusted trial balance at the end of the current year shows: Accounts Receivable $30,000 Dr. Sales Revenue $180,000 Cr. Allowance for Doubtful Accounts $2,000 Dr. Bad debts are estimated to be 10% of receivables. Prepare the entry to adjust Allowance for Doubtful Accounts. SOLUTION Bad Debt Expense 5,000 * Allowance for Doubtful Accounts 5,000 * [(10% x $30,000) + $2,000] Bad Debt Expense DO IT! 2a LO 2

24. 8-24  Finance company or bank.  Buys receivables from businesses and then collects the payments directly from the customers.  Typically charges a commission to the company that is selling the receivables.  Fee ranges from 1% to 3% of the receivables purchased. Sale of Receivables to a Factor DISPOSING OF ACCOUNTS RECEIVABLES LO 2

25. 8-25 Illustration: Assume that Hendredon Furniture factors $600,000 of receivables to Federal Factors. Federal Factors assesses a service charge of 2% of the amount of receivables sold. The journal entry to record the sale by Hendredon Furniture is as follows. Accounts Receivable 600,000 Cash 588,000 Service Charge Expense 12,000 ($600,000 x 2% = $12,000) Sale of Receivables to a Factor LO 2

26. 8-26  Retailer pays card issuer a fee of 2 to 4% of the invoice price for its services.  Recorded the same as cash sales.  Advantages to retailer: ► Issuer does credit investigation of customer. ► Issuer maintains customer accounts. ► Issuer undertakes collection and absorbs losses. ► Receives cash more quickly. National Credit Card Sales DISPOSING OF ACCOUNTS RECEIVABLES LO 2

27. 8-27 Illustration: Morgan Marie purchases $1,000 of compact discs for her restaurant from Sondgeroth Music Co., and she charges this amount on her Visa First Bank Card. The service fee that First Bank charges Sondgeroth Music is 3%. Sondgeroth Music’s entry to record this transaction on March 22, 2017, is as follows. Sales Revenue 1,000 Cash 970 Service Charge Expense 30 National Credit Card Sales LO 2

28. 8-28 Peter M. Kell Wholesalers Co. needs to raise $120,000 in cash to safely cover next Friday’s employee payroll. Kell has reached its debt ceiling. Kell’s present balance of outstanding receivables totals $750,000. Kell decides to factor $125,000 of its receivables on September 7, 2017, to alleviate this cash crunch. Record the entry that Kell would make when it raises the needed cash. (Assume a 1% service charge.) SOLUTION Cash123,750 Service Charge Expense1,250 * (1% x $125,000) Factoring DO IT! 2b Accounts Receivable125,000 * LO 2

29. 8-29 Companies may grant credit in exchange for a promissory note. A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. Promissory notes may be used 1.when individuals and companies lend or borrow money, 2.when amount of transaction and credit period exceed normal limits, or 3.in settlement of accounts receivable. LEARNING OBJECTIVE Explain how companies recognize, value, and dispose of notes receivable. 3 LO 3

30. 8-30 To the payee, the promissory note is a note receivable. To the maker, the promissory note is a note payable. ILLUSTRATION 8-12 Promissory note NOTES RECEIVABLE LO 3

31. 8-31 Maturity date of a promissory note may be stated in one of three ways: 1.On demand. 2.On a stated date. 3.At the end of a stated period of time. Note terms are expressed in:  Months  Days DETERMINING THE MATURITY DATE LO 3

32. 8-32 COMPUTING INTEREST ILLUSTRATION 8-13 Formula for computing interest When counting days, omit the date the note is issued, but include the due date. ILLUSTRATION 8-14 Computation of interest LO 3

33. 8-33 Illustration: Brent Company wrote a $1,000, two-month, 8% promissory note dated May 1, to settle an open account. Prepare entry would Wilma Company makes for the receipt of the note. Notes Receivable 1,000 May 1 Accounts Receivable—Brent Company 1,000 RECOGNIZING NOTES RECEIVABLE LO 3

34. 8-34  Report short-term notes receivable at their cash (net) realizable value.  Estimation of cash realizable value and recording bad debt expense and related allowance are similar to accounts receivable. VALUING NOTES RECEIVABLE LO 3

35. 8-35  Notes may be held to their maturity date.  Maker may default and payee must make an adjustment to the account.  Holder speeds up conversion to cash by selling the note receivable. DISPOSING OF NOTES RECEIVABLE LO 3

36. 8-36 Honor of Notes Receivable A note is honored when its maker pays it in full at its maturity date. Dishonor of Notes Receivable A dishonored note is not paid in full at maturity. Dishonored note receivable is no longer negotiable. DISPOSING OF NOTES RECEIVABLE LO 3

37. 8-37 Illustration: Wolder Co. lends Higley Inc. $10,000 on June 1, accepting a five-month, 9% interest note. If Wolder presents the note to Higley Inc. on November 1, the maturity date, Wolder’s entry to record the collection is: Cash 10,375Nov. 1 Notes Receivable 10,000 Interest Revenue 375 ($10,000 x 9% x 5/12 = $375) Honor of Notes Receivable LO 3

38. 8-38 Interest Receivable 300Sept. 1 Interest Revenue 300 ($10,000 x 9% x 4/12 = $ 300) Illustration 8-15 Timeline of interest earned Illustration: Suppose instead that Wolder Co. prepares financial statements as of September 30. The adjusting entry by Wolder is for four months ending Sept. 30. Accrual of Interest Receivable LO 3

39. 8-39 Illustration: Prepare the entry Wolder’s would make to record the honoring of the Higley note on November 1. Cash 10,375 Notes Receivable 10,000 Interest Receivable 300 Interest Revenue ($10,000 × 9% × 1/12) 75 Nov. 1 Accrual of Interest Receivable LO 3

40. 8-40 Gambit Stores accepts from Leonard Co. a $3,400, 90-day, 6% note dated May 10 in settlement of Leonard’s overdue open account. The note matures on August 8. What entry does Gambit make at the maturity date, assuming Leonard pays the note and interest in full at that time? SOLUTION Notes Receivable DO IT! 3 Interest payable at maturity date = $3,400 × 6% × 90/360 = $51 Cash 3,451 Notes Receivable 3,400 Interest Revenue 51 LO 3

41. 8-41 Illustration 8-16 Balance sheet presentation of receivables LEARNING OBJECTIVE Describe the statement presentation of receivables and the principles of receivables management. 4 LO 4

42. 8-42 Managing accounts receivable involves five steps: 1.Determine to whom to extend credit. 2.Establish a payment period. 3.Monitor collections. 4.Evaluate the liquidity of receivables. 5.Accelerate cash receipts from receivables when necessary. MANAGING RECEIVABLES LO 4

43. 8-43  If the credit policy is too tight, you will lose sales.  If the credit policy is too loose, you may sell to customers who will pay either very late or not at all.  It is important to check references on potential new customers as well as periodically to check the financial health of continuing customers. Extending Credit MANAGING RECEIVABLES LO 4

44. 8-44  Companies should determine a required payment period and communicate that policy to their customers.  The payment period should be consistent with that of competitors. Establishing a Payment Period MANAGING RECEIVABLES LO 4

45. 8-45  Companies should prepare an accounts receivable aging schedule at least monthly. ► Helps managers estimate the timing of future cash inflows. ► Provides information about the collection experience of the company and identifies problem accounts.  Significant concentrations of credit risk must be discussed in the notes to its financial statements. Monitoring Collections MANAGING RECEIVABLES LO 4

46. 8-46 Accounts Receivable Turnover:  Assess the liquidity of the receivables.  Measure the number of times, on average, a company collects receivables during the period. Average collection period:  Used to assess effectiveness of credit and collection policies.  Collection period should not exceed credit term period. EVALUATING LIQUIDITY OF RECEIVABLES LO 4

47. 8-47 ILLUSTRATION 8-19 Accounts receivable turnover and average collection period EVALUATING LIQUIDITY OF RECEIVABLES LO 4

48. 8-48 Three reasons for the sale of receivables: 1.Size. 2.Companies may sell receivables because they may be the only reasonable source of cash. 3.Billing and collection are often time-consuming and costly. ACCELERATING CASH RECEIPTS LO 4

49. 8-49 MANAGING RECEIVABLES Illustration 8-20 Managing receivables LO 4