1. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 8 1

2. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2 Define and explain common types of receivables and review internal controls for receivables Use the allowance method to account for uncollectibles Understand the direct write-off method for uncollectibles Journalize credit-card and debit-card sales

3. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 3 Account for notes receivable Report receivables on the balance sheet and evaluate a company using the acid- test ratio, days’ sales in receivables, and the accounts receivable turnover ratio Discount a note receivable (see Appendix 8A)

4. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Define and explain common types of receivables and review internal controls for receivables 4 1 1

5. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Selling goods or services to another party on credit Right to receive cash in the future from a current transaction Two types: Accounts receivable Notes receivable An asset 5

6. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Amounts to be collected from customers for sales on credit Serves as a control account Customer ledger 6

7. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. More formal than accounts receivable Usually longer in term Current assets if due within one year or less Long-term assets if due beyond one year Promissory note 7

8. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Credit department evaluates customers’ applications Separation of duties 8

9. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. What is the difference between accounts receivable and notes receivable? 9

10. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Use the allowance method to account for uncollectibles 10 2 2

11. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Selling on credit: BENEFIT–Increase sales by selling to a wider range of customers COST–Some customers don’t pay Results in uncollectible account expense Two methods to account for uncollectible accounts: Allowance method Direct write-off method 11

12. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Starts with selling on account Collecting cash is the second step 12

13. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Based on the matching principle Offset to expense is the allowance for uncollectible accounts 13

14. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Companies use their history, the economy and industry information to estimate uncollectibles Percent-of-sales Aging-of-accounts 14

15. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Begins with account balances Beginning balance below Compute the estimate and journalize it Net realizable value is the expected amount to collect 15

16. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. During its first year of operations, Spring Garden Plans earned revenue of $322,000 on account. Industry experience suggests that bad debts will amount to 2% of revenues. At December 31, 2012, accounts receivable total $36,000. The company uses the allowance method to account for uncollectibles. 16

17. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Journal Entry DATEACCOUNTS AND EXPLANATIONSDEBITCREDIT 1.Journalize Spring’s sales and uncollectible account expense using the percent-of sales method. 17

18. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2. Show how to report accounts receivable on the balance sheet at December 31, 2012. Use the long reporting format illustrated in the chapter. 18

19. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Focuses on actual age of the accounts receivable Determines a target allowance balance 19

20. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The amount not expected to be collected becomes the allowance account target balance Journal entry $150 credit balance plus/minus adjustment = $400 20

21. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Summer and Sandcastles Resort had the following balances at December 31, 2012, before the year-end adjustments: The aging of accounts receivable yields the following data: 21 Accounts receivable Allowance for uncollectible accounts Age of Accounts Receivable 0-60 daysOver 60 DaysTotal Receivables Amount receivable % uncollectible Amount uncollectible $3,000+ $720= $ 3,720

22. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1.Journalize Summer’s entry to adjust the allowance account to its correct balance at December 31, 2012. 2.Prepare a T-account to compute the ending balance of Allowance for uncollectible accounts. 22 Accounts receivable Allowance for uncollectible accounts Journal Entry DATEACCOUNTS AND EXPLANATIONSDEBITCREDIT

23. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. When a specific customer account is identified as uncollectible, it is written off to the allowance account 23

24. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Sometimes a customer will pay the amount owed after the customer’s account is written off Two entries needed: Reverse the uncollectable account Record the payment 24

25. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Make sales on account Establish a pool for future potential uncollectibility (2%) Collect cash on account Identify a bad debt Adjust allowance account to reflect adjustments to the estimate Recover previously written off account 25

26. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 26

27. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Understand the direct write-off method for uncollectibles 27 3 3

28. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Used by small businesses No Allowance for uncollectible accounts Records uncollectible accounts expense when specific account is written off 28

29. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Overstates Accounts receivable on the balance sheet Violates matching principle 29

30. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Direct write-off of debt recovery process is different from the allowance method The debt was written off the books To recover: Reverse the write-off journal entry Record the cash payment 30

31. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Gate City Cycles had trouble collecting its account receivable from Sue Ann Noel. On June 19, 2012, Gate City finally wrote off Noel’s $700 account receivable. Gate City turned the account over to an attorney, who hounded Noel for the rest of the year. On December 31, Noel sent a $700 check to Gate City Cycles with a note that said, “Here’s your money. Please call off your bloodhound!” 1. Journalize the entries required for Gate City Cycles, assuming Gate City uses the direct write-off method. 31

32. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 32 Journal Entry DATEACCOUNTS AND EXPLANATIONSDEBITCREDIT Jun19 Dec31 Dec31

33. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Journalize credit-card and debit-card sales 33 4 4

34. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Credit-card sales are an alternative form for receiving payments Two types: Issued by a financial institution Issued by a credit card company 34

35. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Different than credit and bankcards Same as cash Amount subtracted from buyer’s bank account Amount added to retailer’s bank account 35

36. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Retailers receive cash at time of sale Visa and MasterCard most common bank cards Retailer accepting the credit cards pays a fee Two types of fee transactions: NET: The total sale less the processing fee assessed equals the net amount of cash deposited Gross: The total sale is deposited and the fee is deducted at the end of the month Journal entry similar to cash sales 36

37. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Restaurants do a large volume of business by credit and debit cards. Suppose Chocolate Passion restaurant had these transactions on January 28, 2012: National Express credit-card sales..... $ 9,300 ValueCard debit-card sales........... 9,000 Suppose Chocolate Passion’s processor charges a 3% fee and deposits sales net of the fee. Requirement: 1. Journalize these sale transactions for the restaurant. 37

38. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 38 Journal Entry DATEACCOUNTS AND EXPLANATIONS POST. REF.DEBITCREDIT Jan28 National Express credit-card sales..... $ 9,300 ValueCard debit-card sales........... 9,000

39. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Account for notes receivable 39 5 5

40. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. More formal than Accounts receivable Debtor signs promissory note A written promise to pay a specified amount of money at a particular future date 40

41. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 41

42. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Maturity date can be: A specific date, such as March 13 Stated in terms of number of months Stated in terms of number of days 42

43. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. A 180-day note dated February 16, 2014 matures on August 15, 2014 43

44. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. By the year By the month By the day 44

45. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. If notes receivable are outstanding, interest must be accrued Interest is earned over time Revenue must be recorded in the period earned 45

46. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. On the maturity date 46

47. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 47

48. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 48

49. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. A company may accept a note receivable from a customer who fails to pay an account receivable 49

50. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Lakeland Bank & Trust Company lent $110,000 to Samantha Michael on a 90-day, 9% note. 1. Journalize the following transactions for the bank (explanations are not required): a.Lending the money on June 6. b.Collecting the principal and interest at maturity. Specify the date. For the computation of interest, use a 360-day year. 50

51. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 51 Journal Entry DATEACCOUNTS AND EXPLANATIONS POST. REF. DEBITCREDIT Jun6 Sept6Cash112,475 Note receivable—S. Michael110,000 Interest revenue2,475 ($110,000 ×.09 × 90/360) a.Lending the money on June 6. b.Collecting the principal and interest at maturity. Specify the date. For the computation of interest, use a 360-day year.

52. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Maker of note does not pay Move the note receivable into accounts receivable Interest is added to the new accounts receivable 52

53. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Accounts receivable can be computerized allowing the order entry, shipping, and billing departments to work together 53

54. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Report receivables on the balance sheet and evaluate a company using the acid-test ratio, days’ sales in receivables, and the accounts receivable turnover ratio 54 6 6

55. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Current asset, shown net of allowances Two presentation styles: 55

56. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Also called the “quick ratio” Stringent measure of liquidity Measures entity’s ability to pay its current liabilities immediately 56

57. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Also called “collection period” It is number of days it takes to collect the average balance of receivables The shorter the collection period, the more quickly cash is available Two step process: Find one day’s sales Find day’s sales in receivables 57

58. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Step 1: One day’s sales is calculated Net sales (Total revenues) divided by 365 days per year 58

59. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Step 2: Day’s sales in inventory Average net receivables divided by one days sales 59

60. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Measures the number of times the company sells and collects the average receivables Higher the ratio, the faster the cash collections occur Benchmark on how well a company is managing its receivables 60

61. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Northend Medical Center included the following items in its financial statements: 1.How much net income did Northend earn for the month? 61 Service revenue............................................………… Less: Cost of services sold and other expenses… Net income.........................................…………………

62. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2. Show two ways Northend can report receivables on its classified balance sheet: 62 Current assets: Accounts receivable.............................…………... Less: Allowance for doubtful accounts............. Accounts receivable, net................................…... or Accounts receivable, net of allowance for uncollectible accounts of $150…………...

63. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Southside Clothiers reported the following items at September 30, 2012 (last year’s—2011—amounts also given as needed): Compute Southside’s (a) acid-test ratio, (b) days’ sales in average receivables for 2012, and (c) accounts receivable turnover ratio. Evaluate each ratio value as strong or weak. Southside sells on terms of net 30. 63

64. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 64 (a)Acid-test ratio = Cash + Short-term investments + Net current receivables Total current liabilities

65. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. (b) Days’ sales in average receivables = * Average net accounts receivable ** One day’s sales *Average net accounts receivable= **One day’s sale=(Net sales/365 days) = $ = 65 =

66. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 66 (c) Accounts receivable Turnover Ratio = Net sales revenue Average net accounts receivable = =

67. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Discount a note receivable (see Appendix 8A) 67 7 7

68. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The payee needs cash before the maturity date Payee sells the receivables Amount is determined by present-value concepts 68

69. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Compute the original amount of interest on the note receivable Maturity value of the note = Principal + Interest Determine the period (number of days, months, or years) the bank will hold the note (the discount period) Compute the bank’s discount on the note This is the bank’s interest revenue from holding the note Seller’s proceeds from discounting the note receivable = Maturity value of the note – Bank’s discount on the note 69

70. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. $1,000 note is received on September 30, 2015 Maturity date is one year Note is discounted on November 30, 2014 Interest applied is 12%, and is higher than notes Amounts received is called proceeds 70

71. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. If proceeds are less than principle amount, the payee debits Interest expense If proceeds are greater than principle amount, the payee debits Interest revenue 71

72. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 72

73. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. 73