1. 201Lec08.PPTX 1 Amounts due from individuals and other companies that are expected to be collected in cash. Trade Receivables are owed by customers that result from the sale of goods and services. A/R are not supported by a formal document. Accounts Receivable Notes Receivable “Nontrade” (interest, loans to employees or officers, income tax refunds, etc). Other Receivables ReceivablesReceivables 8

2. Balance sheet: What amount should be used? Income statement: When should bad debt expense be recorded? Example: Assume Chuck Co. has: $1,000,000 of sales in December 2013, its first year. All are on credit, terms net 90 days. Gross profit is 40%, operating expenses are $30,000. Now assume that half of all A/R are uncollectible due to poor credit screening and customer bankruptcies. 2 Issues regarding receivables addressed by GAAP:

3. Allowance Method A/R 1,000,000 - uncollectible - 500,000 Net realizable 500,000 ------------------------------------- Sales 1,000,000 CGS -600,000 Gross profit 400,000 -Operating exp- 30,000 -Bad debt exp - 500,000 Net loss -130,000 Options Options for 2013 Balance Sheet and Income Statement: 3 Direct Method A/R 1,000,000 ----------------------------------- Sales 1,000,000 CGS -600,000 Gross profit 400,000 - Operating exp - 30,000 Net income 370,000

4. All receivables should be reported their... Realizable Value This is the net amount that the company can reasonably expect to collect in cash. 4 GAAP Required Balance Sheet Presentation:

5. Companies don’t know which or when specific receivables will be bad, so.... 5 they estimate amounts they think are uncollectible. Use a CONTRA Accounts Receivable account called: Allowance for Doubtful Accounts

6. Example: Accounts Receivable reporting Konk Co. has sales of $5,000,000, of which $700,000 remains uncollected at year end. At year end, December 31, the credit manager estimates $92,000 will prove uncollectible. 6

7. Konk Co. Balance Sheet (partial) Current assets Cash $ 14,800 Accounts receivable$700,000 Less: Allowance for doubtful accounts - 92,000 608,000 Called “Cash (net) Realizable Value” = expected cash collections

8. When... Review all A/R at same time adjusting entries are made (at period end) How... Many techniques. Age of A/R is most common method (shown later) Adjusting Journal entry: BAD DEBT EXPENSE xxxx Allowance for Doubtful Accounts xxxx 8 Recording estimates in the Allowance Account:

9. is an operating expense on the Income Statement. is an estimate. 9 Bad Debt Expense: Determining a certain debt is bad won’t be known until some time in the future (maybe a couple of years!). - Occurs when a specific customer’s A/R is found out to be worthless. (bankruptcy, etc.) - Journal entry is made at this time called a “Write off” Allowance for Doubtful Accounts xxxx Accounts Receivable xxxx

10. Go back to previous Example Konk Co. has credit sales of $5,000,000, of which $700,000 remains uncollected at year end. The credit manager estimates $92,000 will prove uncollectible. 12/31 Adjusting entry to record allowance and bad debt: Bad Debt Expense 92,000 Allowance for Doubtful Accounts 92,000 10

11. On March 1 of next year, a write-off is needed for $500 owed by I. M. Bad who went bankrupt. Allowance for Doubtful Accounts 500 Accounts Receivable500 Now assume a write-off is needed: Accounts Receivable Allowance for Doubtful Accounts Jan 1 Bal 700,000Mar 1 500 Mar 1 Bal 699,500 Jan 1 Bal 92,000Mar 1 500 Mar 1 Bal 91,500 11

12. Accounts receivable$700,000$699,500 Allowance for doubtful accts - 92,000 - 91,500 Cash realizable value$608,000$608,000 Before Write-off After Write-off Effect of a write off: 12

13. Estimating Bad Debts - Aging Receivables PROCESS of ESTIMATION First breakout A/R into classes based on how old they are. Called an aging schedule. Multiply each class by bad debt %. Older classes have higher %. (less likely they will be paid!) ending balance This result is the desired ending balance in the allowance account. Entry adjusts existing balance to desired balance. 13

14. 14 Accounts Receivable AGING Schedule

15. EXAMPLE: A/R: Not Due Yet 10,000 1-30 days past 4,000 31 and older 2,000 16,000 Allowance for doubtful accounts 100 credit ALLOWANCE FOR DOUBTFUL ACCOUNTS 100. 1900..05 x 10000= 500.10 x 4000= 400.50 x 2000=1000 1900 Bad debt expense 1,800 Allowance for doubtful accounts 1,800 ???? 15 Bad debts = 5% of not due, 10% of 1-30 past, 50% over 30.

16. ALLOWANCE FOR DOUBTFUL ACCOUNTS 100. 1900. 455. 230. 60. 75. 355. 580. 190. 45. 1800. Estimated side Actual side 16

17. Allowance not used. (This is a crumby method) Wait to record bad debt expense when a specific A/R is found to be uncollectible. BAD DEBT EXPENSExxxx A/Rxxxx A/R on balance sheet overstate amounts realistically expected to be received in cash. Doesn’t match expenses to revenues. NOT GAAP. Use only if bad debts are negligible. 17 Bad Debt Alternative- DIRECT CHARGE OFF

18. Normally requires payment of interest To the Maker, the promissory note is a note payable. To the Payee, the promissory note is a note receivable. 18 Notes Receivable

19. Computing Interest 19 Examples: Notes Receivable

20. On Maturity, maker pays principal + interest Interest is recorded in period earned Remember “cut off” for adjusting entries. 20 Year end Note receivedMaturity Interest revenue Notes Receivable

21. EXAMPLE: On December 1 receive note with Face = $120,000, Life = 90 days, Rate = 10% December 1 Notes Receivable 120,000.00 Cash, Sales, A/R,etc 120,000.00 Use when you get note. Ignore interest to be earned. On maturity, receive: Principal 120,000 + Interest (120,000)(.10)(90/360) = 120,000 + 3,000.00 = 123,000.00. 21

22. If year end is 12/31, record interest earned with adjusting on December 31 Interest Receivable 1,000.00 Interest Income 1,000.00 $3,000 interest for 90 days, so 1/3 is earned in 30 days. 22

23. When note collected at maturity on February 28 CASH 123,000.00 N/R120,000.00 INTEREST INCOME 2,000.00 INTEREST RECEIVABLE 1,000.00 If they don’t pay when due (dishonor), write-off to allowance or record as A/R if collection still possible. 23

24. Receivables often viewed as necessary evils of business Receivables hinder cash flow and extend the operating cycle. Cash is better, but competition, marketing, consumer’s buying habits and economic conditions make sales on credit critical to generating revenues! 24 Managing Receivables

25. 1.Allow credit card charges - Retailer pays a % fee to card company - Non-payment becomes card companies expense - Bank cards (VISA & MC) are considered same as cash by bank upon deposit. 25 Methods used in managing receivables

26. 2.Sell receivables to a “factor” - Fees are charged. - Customers make payments to factor. - Payment of receivables is usually guaranteed by selling company. - Selling notes receivable is called Discounting. 3.Provide terms as incentive for customers to pay sooner. (Chapter 5, such as 2/10, n/30) 4.Require credit references or perform credit checks on customers (Dun & Bradstreet, Equifax) 26 Methods used in managing receivables

27. 5.Monitor collections. Establish policy for overdue accounts. Helpful ratios include: a) A/R Turnover = Net Credit Sales Average A/R Relates to how fast cash is collected. b) Average Collection Period (age of receivables) in days equals: 365 days / receivables turnover. Usually, high turnover is good. Means less money is tied up in receivables, better cash flow. 27 Methods used in managing receivables