2. Accounting Principles Second Canadian Edition Prepared by: Carole Bowman, Sheridan College Edited by: Carolyn Doering, Huron Heights SS Weygandt · Kieso · Kimmel · Trenholm

3. ACCOUNTING FOR RECEIVABLES CHAPTER 9

4. The term receivables refers to amounts due from individuals and other companies; they are claims expected to be collected in cash. Three major classes of receivables are: 1. Accounts Receivable 2. Notes Receivable 3. Other Receivables RECEIVABLESRECEIVABLES

5. The three primary accounting issues associated with accounts receivable are: 1. Recognizing accounts receivable 2. Valuing accounts receivable 3. Disposing of accounts receivable ACCOUNTS RECEIVABLE

6. July 1 1,000 To record sales on account. 1,000 GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit Accounts Receivable - Adorable Junior Sales RECOGNIZING ACCOUNTS RECEIVABLE When a business sells merchandise to a customer on credit, Accounts Receivable is debited and Sales is credited.

7. 100 RECOGNIZING ACCOUNTS RECEIVABLE con’t When a business receives returned merchandise previously sold to a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 5Sales Returns and Allowances Accounts Receivable - Adorable 100 To record merchandise returned.

8. 900 RECOGNIZING ACCOUNTS RECEIVABLE con’t GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 31Cash ($1,000 - $100) Accounts Receivable - Adorable 900 To record collection of account. When a business collects cash from a customer for merchandise previously sold on credit, Cash is debited and Accounts Receivable is credited.

9. 13.50 RECOGNIZING ACCOUNTS RECEIVABLE con’t GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 31Accounts Receivable - Adorable Interest Revenue 13.50 To record interest on amount due. When financing charges are added to a balance owing, Accounts Receivable is debited and Interest Revenue is credited. (ie. overdue account)

10. They are recorded as a current asset To ensure that receivables are not overstated on the balance sheet, they are stated at their net realizable value. Net realizable value is the net amount expected to be received in cash and excludes amounts that the company estimates it will not be able to collect. VALUING ACCOUNTS RECEIVABLE

11. METHODS TO COLLECT PAST DUE ACCOUNTS Sending a sequence of letters Phone calls Legal action If these methods do not work, then sometimes receivables must be written off

12. Two methods of accounting for uncollectible accounts are: 1. Allowance method 2. Direct write-off method VALUING ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLEVALUING

13. Under the direct write-off method, no entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to Bad Debts Expense. No attempt is made to match bad debts to sales revenues or to show the net realizable value of accounts receivable on the balance sheet. (ie. could be in a different fiscal period—easy method, but unacceptable for financial reporting purposes) DIRECT WRITE-OFF METHOD

14. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit Jan. 12Bad Debts Expense Accounts Receivable — E. Schaefer For write-off of E. Schaefer account. DIRECT WRITE-OFF METHOD Periera Company writes off E. Schaefer’s $200 balance as uncollectible on January 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles. 200 200

15. The allowance method is required when bad debts are deemed to be material in amount. Uncollectible accounts are estimated and the expense for the uncollectible accounts is matched against sales in the same accounting period in which the sales occurred. The estimate is made at the end of each reporting period. THE ALLOWANCE METHOD

16. Estimated uncollectible amounts are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts (a contra asset account) at the end of each period. THE ALLOWANCE METHOD (ESTIMATED UNCOLLECTIBLES) THE ALLOWANCE METHOD (ESTIMATED UNCOLLECTIBLES)

17. ADORABLE JUNIOR GARMET Balance Sheet (partial) Current assets Cash $ 14,800 Accounts receivable$200,000 Less: Allowance for doubtful accounts 24,000 176,000 Net Realizable Value

18. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit Mar. 1Allowance for Doubtful Accounts Accounts Receivable — Nadeau Write-off of Nadeau account. Actual uncollectible accounts are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off. THE ALLOWANCE METHOD (WRITE-OFF OF ACTUAL UNCOLLECTABLE ACCOUNT) THE ALLOWANCE METHOD (WRITE-OFF OF ACTUAL UNCOLLECTABLE ACCOUNT) 500 500

19. When there is recovery of an account that has been written off: 1. reverse the entry made to write off the account and... THE ALLOWANCE METHOD (RECOVERY OF AN UNCOLLECTIBLE ACCOUNT) THE ALLOWANCE METHOD (RECOVERY OF AN UNCOLLECTIBLE ACCOUNT) GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 1Accounts Receivable — Nadeau Allowance for Doubtful Accounts To reverse write-off of Nadeau account. 500 500

20. THE ALLOWANCE METHOD GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 1Cash Accounts Receivable —Nadeau To record collection from Nadeau. 500 500 2. Record the collection in the usual manner.

21. Companies use either of two methods in the estimation of uncollectible accounts: 1. Percentage of sales 2. Percentage of receivables Both bases are GAAP; the choice is a management decision. BASES USED FOR THE ALLOWANCE METHOD

22. ILLUSTRATION 9-4 COMPARISON OF BASES OF ESTIMATING UNCOLLECTIBLES Percentage of Sales Percentage of Receivables Net Realizable Value Allowance Accountsfor ReceivableDoubtful Accounts Emphasis on Income Statement Relationships Emphasis on Balance Sheet Relationships

23. In the percentage of sales basis, management establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. This is based on past experience and anticipated credit policy. Expected bad debt losses are determined by applying the percentage to the sales base of the current period. This basis better matches expenses with revenues. PERCENTAGE OF SALES BASIS

24. PERCENTAGE OF SALES EXAMPLE Pierra Company decides that 1% of net credit sales will be uncollectible based on last years figures. Net sales for the year are $170,000. Dec 31 Bad Debts Expense1700 Allowance for Doubtful Accounts1700 To record estimated bad debts for the year.

25. Under the percentage of receivables basis, management establishes a percentage relationship between the amount of accounts receivable and the required balance in the allowance account. This percentage can be applied to the total accounts receivable balance, or to individual accounts receivable balances stratified by age. PERCENTAGE OF RECEIVABLES BASIS

26. The required balance in the allowance account is determined by applying the percentage to the accounts receivable balance at the end of the current period. The amount of the adjusting entry to record expected bad debt losses for the current period is the difference between the required balance and the existing balance in the allowance account. This basis produces the better estimate of net realizable value of receivables. PERCENTAGE OF RECEIVABLES BASIS

27. PERCENTAGE OF RECEIVABLES EXAMPLE CustomerTotal Number of Days Outstanding 0-3031-6061-9091-120Over 120 E. Bansal $600$300$200$100 C. Bortz 300$300 A. Rashad 450200$250 Others 38,25026,70052002,7501,800 TOTALS $39,600$27,000$5,700$3,000$2,000$1,900 Estimated Percentage 2%4%10%50%75% Estimated Bad Debts $3,493$540$228$300$1000$1,425

28. PERCENTAGE OF RECEIVABLES EXAMPLE con’t The amount of the bad debt adjusting entry is the difference between the required balance and the existing balance in the allowance account. If the trial balance shows $1,793 in the account, then ($3493-1793=1700): Dec. 31 Bad Debts Expense1700 Allowance for Doubtful Accounts1700 To adjust allowance account to total estimated uncollectibles

29. To accelerate the receipt of cash from receivables, owners frequently: 1. sell to a factor, such as a finance company or a bank, and 2. make credit card sales. DISPOSING OF ACCOUNTS RECEIVABLE

30. A factor buys receivables from businesses for a fee and collects the payments directly from customers. Credit cards are frequently used by retailers who wish to avoid the paperwork of issuing credit. Retailers can receive cash more quickly from the credit card issuer. DISPOSING OF ACCOUNTS RECEIVABLE

31. Three parties are involved when credit cards are used in making retail sales: 1. the credit card issuer, 2. the retailer, and 3. the customer. The retailer pays the credit card issuer a percentage fee of the invoice price for its services. From an accounting standpoint, sales from bank cards (e.g., Visa and MasterCard) are treated differently than sales from non-bank cars (e.g., American Express). CREDIT CARD SALES

32. BANK CARD SALES Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer. These cards are issued by banks. Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller’s bank balance.

33. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 31Cash Credit Card Expense ($1,000 x 3.5%) Sales To record VISA credit card sales. BANK CARD SALES Anita Ferreri purchases a number of compact discs for her restaurant from Karen Kerr Music Co. for $1,000 using her Royal Bank VISA card. The service fee that the Royal charges is 3.5 percent. 965 35 1,000

34. NON-BANK CARD SALES Sales using American Express and other non-bank cards are reported as credit sales, not cash sales. Conversion into cash does not occur until American Express remits the net amount to the seller.

35. NON-BANK CARD SALES Kerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 31Accounts Receivable- American Express Credit Card Expense ($500 x 5%) Sales To record American Express credit card sales. 475 25 500

36. DEBIT CARD SALES Debit cards allow customers to only spend what is in their bank account The amount is immediately taken from the customers bank account and is transferred to the retailers bank account The retailer is charged approx. 12¢ per transaction regardless of the amount Cash499.88 Debit Card Expense.12 Sales500.00 To record a Debit card sale

37. A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. They are used when companies lend or borrow money or when the amount of the transaction and credit period exceeds normal limits. The party making the promise is the maker. The party to whom payment is made is called the payee. NOTES RECEIVABLE

38. The basic formula for calculating interest on an interest-bearing note is: The interest rate specified on the note is an annual rate of interest. ILLUSTRATION 9-8 FORMULA FOR CALCULATING INTEREST Face Value of Note Annual Interest Rate Time in Terms of One Year Interest X X =

39. RECOGNIZING NOTES RECEIVABLE Wilma Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company to settle an open account. (Note: The interest is not recorded until it is earned—the Revenue Recognition Principle.) 1,000

40. Like accounts receivable, short-term notes receivable are reported at their net realizable value. The notes receivable allowance account is Allowance for Doubtful Notes. VALUING NOTES RECEIVABLE

41. HONOUR OF NOTES RECEIVABLE A note is honoured when it is paid in full at its maturity date. Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5% interest-bearing note, due in 4 months, on September 30. Wolder collects the maturity value of the note from Higley on September 30.

42. DISHONOUR OF NOTES RECEIVABLE A dishonoured note is a note that is not paid in full at maturity. A dishonoured note receivable is no longer negotiable. Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable.

43. BALANCE SHEET PRESENTATION OF RECEIVABLES Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. In the balance sheet, short-term receivables are reported within the current assets section below cash and temporary investments. Both the gross amount of receivables and the allowance for doubtful accounts should be reported.

44. USING THE INFORMATION IN THE FINANCIAL STATEMENTS Financial ratios are calculated to evaluate the short-term liquidity of a company. These ratios include the 1. current ratio, 2. acid test (quick) ratio, 3. receivables turnover ratio, and the 4. collection period ratio.

45. CURRENT RATIO CURRENT ASSETS CURRENT RATIO = ——————————— CURRENT LIABILITIES The current ratio (working capital ratio) is a widely used measure for evaluating a company’s liquidity and short-term debt-paying ability.

46. CASH + TEMPORARY INVESTMENTS + RECEIVABLES (NET) ACID TEST RATIO = ———————————————————————————— CURRENT LIABILITIES ACID TEST RATIO The acid test ratio (quick ratio) is a measure of a company’s short-term liquidity. Only current assets that can be quickly converted to cash are used.

47. ACCOUNTS RECEIVABLE TURNOVER RATIO The ratio used to assess the liquidity of the receivables is the receivables turnover ratio. (The Avg. Net Receivables is the beginning plus ending balances divided by 2) Net Credit Average Net Receivables Sales Receivables Turnover  =

48. COLLECTION PERIOD The collection period in days is a variant of the receivables turnover ratio and makes liquidity even more evident. The general rule is that the collection period should not exceed the credit term period. Days in Year Receivables Collection (365) Turnover Period in Days  =

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