2. 9-1 R ECEIVABLES AND P AYABLES CHAPTER 9

3. 9-2 R ECEIVABLES AND P AYABLES CHAPTER 9 CAUTION ! Most students find this chapter to be the most challenging in the first semester of introductory accounting.

4. 9-3 Accounts Receivable Amounts owed to the company. Arise from credit sales to customers. Not all customers will pay in full.

5. 9-4 Subsidiary Ledger and Control Accounts generalledger Until now, we have assumed that each accounts receivable account will be shown in the general ledger. subsidiaryledger However, because of certain efficiencies, customers’ accounts are actually kept in a subsidiary ledger in practice. controlaccount This practice necessitates the use of a general ledger control account.

6. 9-5 subsidiary ledger general ledger control account. A subsidiary ledger is a group of related accounts which show the details of the balance of a general ledger control account. general ledger controlaccount A general ledger control account shows the total balance of all the subsidiary accounts related to it. Subsidiary Ledger and Control Accounts

7. 9-6 Accounts Receivable Control Account General Ledger Subsidiary Ledger Customer A Customer DCustomer C Customer B 2,500 1,500 500 1,000 Bal. 5,500 Subsidiary Ledger and Control Accounts

8. 9-7 Until now, we have also assumed that all accounts receivable will be collected. However, because of various circumstances, some customers will not be able to keep their promises to pay. Uncollectible Accounts

9. 9-8 As a result, businesses must record the fact that some customers will not ever pay their account. estimate Therefore, at the end of each year, an adjusting entry is made to record an estimate of the uncollectible accounts (i.e., “bad debts”) related to the period. Uncollectible Accounts

10. 9-9 Why use an estimate? Why not wait until a specific customer fails to pay and use an exact amount? Matching Principle. ANSWER: The Matching Principle. 1994 1995 1996 Sales XXX Expenses -XX Net Income X Uncollectible Accounts

11. 9-10 who When the adjusting entry is made, we do not know who the customers are who will not pay. estimate We only know that some of the customers will likely not be able to pay. That is why we have to use an estimate for the entry. Uncollectible Accounts

12. 9-11 Direct Write-Off Method Allowance Method Methods to Account for Uncollectible Accounts Uncollectible Accounts

13. 9-12 Uncollectible Accounts Direct Write-Off Method Allowance Method Methods to Account for Uncollectible Accounts GAAP

14. 9-13 Allowance Method Record an estimate of uncollectible accounts expense in the period the revenue is generated. Adheres to the matching principle.

15. 9-14 GENERAL JOURNAL Page 34 DateDescription Post. Ref.DebitCredit Allowance Method Adjusting entry to record the estimate of uncollectible accounts expense:

16. 9-15 GENERAL JOURNAL Page 34 DateDescription Post. Ref.DebitCredit Uncollectible Accounts ExpenseXXX Allowance for Uncollectible AccountsXXX Allowance Method Adjusting entry to record the estimate of uncollectible accounts expense: Classified as a selling expense on the income statement. Classified as a contra-asset account on the balance sheet.

17. 9-16 Accounts receivable Less:Allowance for uncollectible accounts Net realizable value of accounts receivable The net realizable value is the amount of the accounts receivable that the business expects to collect (i.e., the true asset). Allowance Method

18. 9-17 Allowance Method How is the estimate for the adjusting entry determined? You will meet a woman who will pay off all your accounts...

19. 9-18 Two approaches for estimating Uncollectible Accounts ¶ Percentage-of-Sales · Percentage-of-Receivables Allowance Method

20. 9-19Percentage-of-Sales Percentage is estimated based on actual uncollectible accounts from prior years’ credit sales. Focus is on determining the amount to record on the income statement as uncollectible accounts expense. SALES

21. 9-20Percentage-of-Sales SALES

22. 9-21 a. $ 750. b. $4,750. c. $5,500. d. No entry is needed. Percentage-of-Sales Question During 1998, Tools Etc. had total sales of $550,000, of which $75,000 were cash sales. In the past, Tools Etc.’s bad debt percentage has been 1% of credit sales. On 12/31, Tools Etc. will credit the Allowance for Uncollectible Accounts

23. 9-22 a. $ 750. b. $4,750. c. $5,500. d. No entry is needed. Percentage-of-Sales Question During 1998, Tools Etc. had total sales of $550,000, of which $75,000 were cash sales. In the past, Tools Etc.’s bad debt percentage has been 1% of credit sales. On 12/31, Tools Etc. will credit the Allowance for Uncollectible Accounts $550,000 Total Sales - 75,000 Cash Sales 475,000 Credit Sales ×.01 $ 4,750

24. 9-23 During 1998, Books, Inc. had total sales of $1,000,000 of which $250,000 were cash sales. In the past, Books Inc.’s bad debt percentage has been ½ of 1% of credit sales. Prepare the adjusting journal entry required for Books, Inc. to record uncollectible accounts expense for 1998. Percentage-of-Sales Example

25. 9-24 Percentage-of-Sales Example $1,000,000 - $250,000 = $750,000 .005 = $3,750

26. 9-25Percentage-of-Receivables Focus is on determining the desired balance in the Allowance for Uncollectible Accounts on the balance sheet. Accounts Receivable

27. 9-26 accounts receivable First, determine the historical bad debt percentage based on accounts receivable. Then, compute the estimated uncollectible amount of accounts receivable by either: (1) Total accounts receivable balance times a single percentage or (2) An aging of accounts receivable times several percentages Percentage-of-Receivables

28. 9-27 desired balance The amount calculated with this method represents the desired balance for the allowance for uncollectible accounts (i.e., the account balance which must result from making the adjusting entry.) Since the allowance for uncollectible accounts is a permanent account and normally has an existing balance, that balance must be considered in determining the amount of the adjusting entry. Percentage-of-Receivables

29. 9-28 adjusting entry Therefore, to determine the amount for the adjusting entry, first compute the amount of the desired balance in the allowance account. Then, compare it with the existing balance in the account. Finally, make the adjusting entry necessary to “force” the required balance. Percentage-of-Receivables

30. 9-29Percentage-of-Receivables Accounts Receivable  % Estimated Uncollectible Desired Balance in Allowance Account +Allowance Account Debit Balance Amount of Journal Entry Accounts Receivable  % Estimated Uncollectible Desired Balance in Allowance Account -Allowance AccountCredit Balance Amount of Journal Entry

31. 9-30 Let’s look at an example for Books, Inc. Percentage-of-Receivables

32. 9-31 At 12/31/98, Books, Inc.’s Accounts Receivable balance was $80,000 and the balance before adjustment in the Allowance for Uncollectible Accounts was $500 (credit). In the past, the uncollectible accounts percentage has been 3% of accounts receivable. Prepare the adjusting journal entry required for Books, Inc. to record uncollectible accounts expense for 1998. Percentage-of-Receivables Example #1

33. 9-32 80,000$  3.00% 2,400 -500 1,900$ Percentage-of-Receivables Example #1 Accounts Receivable  % Estimated Uncollectible Desired Balance in Allowance Account -Allowance AccountCredit Balance Amount of Journal Entry

34. 9-33 Percentage-of-Receivables Example #1

35. 9-34 Percentage-of-Receivables Example #1 ACCOUNT NAME: Allowance for Uncollectible AccountsACCOUNT No.172 DateDescriptionPRDebitCreditBalance 12/31Balance500 12/31Adjusting entryGJ341,9002,400

36. 9-35 Now, let’s look at an example for Geeks, Inc. Percentage-of-Receivables

37. 9-36 At 12/31/98, Geeks, Inc.’s Accounts Receivable balance was $80,000 and the balance before adjustment in the Allowance for Uncollectible Accounts was $500 (debit). Historically, the bad debt percentage based on accounts receivable has been 3%. What would be the adjusting entry to record uncollectible accounts expense for 1998? Percentage-of-Receivables Example #2

38. 9-37 ALLOWANCE FOR UNCOLLECTIBLE ACCTS Bal. Before Adjustment 500 Percentage-of-Receivables Example #2

39. 9-38 ALLOWANCE FOR UNCOLLECTIBLE ACCTS 80,000 x.03 = 2,400 (Desired bal.) Percentage-of-Receivables Example #2 Bal. Before Adjustment 500

40. 9-39 ALLOWANCE FOR UNCOLLECTIBLE ACCTS 80,000 x.03 = 2,400 (Desired bal.) 2,400After Adjustment Percentage-of-Receivables Example #2 Bal. Before Adjustment 500 ??

41. 9-40 2,400After Adjustment ALLOWANCE FOR UNCOLLECTIBLE ACCTS 80,000 x.03 = 2,400 (Desired bal.) -500 + X = 2,400 X = 2,900 Percentage-of-Receivables Example #2 Bal. Before Adjustment 500 ??

42. 9-41 2,900Adjusting Entry 2,400After Adjustment ALLOWANCE FOR UNCOLLECTIBLE ACCTS 80,000 x.03 = 2,400 (Desired bal.) -500 + X = 2,400 X = 2,900 Percentage-of-Receivables Example #2 Bal. Before Adjustment 500

43. 9-42 GENERAL JOURNAL Page 1 DateDescriptionPRDebitCredit 12/31/98Uncollectible Accounts Expense2,900 Allowance for Uncollectible Accts.2,900 To record 1998 estimate for uncollectible accounts Percentage-of-Receivables Example #2

44. 9-43 Now, let’s look at a third example Percentage-of-Receivables

45. 9-44 Percentage-of-Receivables Example #3

46. 9-45 Tools Etc. December 31, 1998 Aging Days Past Due A/R Balance Estimated Bad Debt % Uncollectible Estimate Current45,000$ 1% 1-30 Days15,000 3% 31-60 Days5,000 5% Over 60 Days2,000 10% Total A/R67,000$ Desired Credit Balance Allowance for Uncoll. Accts. Amount for Journal Entry (350) Percentage-of-Receivables Example #3 The December 31 balance in the Allowance for Uncollectible Accounts was $350 (credit).

47. 9-46 Tools Etc. December 31, 1998 Aging Days Past Due A/R Balance Estimated Bad Debt % Uncollectible Estimate Current45,000$ 1% 1-30 Days15,000 3% 31-60 Days5,000 5% Over 60 Days2,000 10% Total A/R67,000$ Desired Credit Balance Allowance for Uncoll. Accts. Amount for Journal Entry (350) Percentage-of-Receivables Example #3 What will be the balance in the Allowance for Uncollectible Accounts after Tools Etc. makes the year-end adjusting entry?

48. 9-47 (350) $ 450 450 250 200 1,350 $ 1,000 Percentage-of-Receivables Example #3 What will be the balance in the Allowance for Uncollectible Accounts after Tools Etc. makes the year-end adjusting entry?

49. 9-48 GENERAL JOURNAL Page 1 DateDescriptionPRDebitCredit 12/31/98Uncollectible Accounts Expense1,000 Allowance for Uncollectible Accts.1,000 To record 1998 estimate for uncollectible accounts Percentage-of-Receivables Example #2

50. 9-49 Write-Off of Receivables specific When it will become apparent that a specific account receivable will not be collected, it must be “written off”.

51. 9-50 The entry to write-off the uncollectible account receivable. Write-Off of Receivables

52. 9-51 Prepare the journal entry to record the following transaction. On March, 28, 1998, Books, Inc. determines that Ready-To-Read’s accounts receivable for $500 is uncollectible. Write-Off of Receivables Example

53. 9-52 Write-Off of Receivables Example

54. 9-53 Now, assume that before the previous entry, the Accounts Receivable balance was $67,000 and the Allowance for Uncollectible Accounts balance was $1,350. Let’s see what effect the write-off had on these accounts. Write-Off of Receivables Example

55. 9-54 Before Write-Off After Write-Off Accounts receivable67,000$66,500$ Less: Allow. for uncollectible accts.1,350 850 Net realizable value65,650$ $ Notice that the $500 write-off did not change the net realizable value (which means that it did not change total assets) nor did it affect any income statement accounts!!!!! Write-Off of Receivables Example.

56. 9-55 Uncollectible Accounts Recovered When a customer makes a payment after an account has been written off, two journal entries are required: ¶ Reverse the write-off.

57. 9-56 Uncollectible Accounts Recovered When a customer makes a payment after an account has been written off, two journal entries are required: · Record the cash collection. Why?

58. 9-57 Credit Card Sales Companies accept credit cards for several reasons: u To increase sales. u To avoid providing credit directly to customers. u To avoid losses due to bad checks. u To receive payment quicker.

59. 9-58 Credit Card Sales When credit card sales are made, the company must pay the credit card company a fee for the service it provides.

60. 9-59 Credit Card Sales On July 6, Kid’s Clothes’ credit card sales were $1,500. The credit card company charges a 2% service fee. Prepare the journal entry.

61. 9-60 Credit Card Sales On July 6, Kid’s Clothes’ credit card sales were $1,500. The credit card company charges a 2% service fee. Prepare the journal entry.

62. 9-61 Obligations payable within one year. Normally are paid using current assets. l Clearly determinable liabilities u e.g. Payroll taxes withheld, etc. l Estimated liabilities u e.g. Product Warranty Current Liabilities

63. 9-62 Contingent Liabilities l Existence of liability and amount depends on (i.e., is contingent on) the outcome of some future event u Examples include: lawsuits, income tax disputes, co-signer of note payable l Must record in accounts if liability is probable and reasonably estimable u However, this is normally not the case l If the contingent liability is not probable and reasonably estimable, how is it disclosed? Notes to the financial statements

64. 9-63 Promissory Notes l An unconditional written promise... l Made & signed by the maker (borrower)... l To pay the payee… l A definite amount of money… l Plus interest (usually)… l On the maturity date… u Or on demand.

65. 9-64 $1200 Wheaton, Illinois January 5, 1999 Sixty days after date I promise to pay to the order of Yankee Brothers, Inc. One thousand two hundred ---------------------------------Dollars Payable at Wheaton Mountain Bank Value received with interest at per annum No. Due The Kitchen Taylor 42March 6, 1999 12% Dennis Taylor Promissory Notes

66. 9-65 $1200 Wheaton, Illinois January 5, 1999 Sixty days after date I promise to pay to the order of Yankee Brothers, Inc. One thousand two hundred ---------------------------------Dollars Payable at Wheaton Mountain Bank Value received with interest at per annum No. Due The Kitchen Taylor 42March 6, 1999 12% Dennis Taylor Payee Maker Interest Rate Principal Due Date Term Promissory Notes

67. 9-66 I = P × R × T InterestPrincipalRateTime “Interesting” Calculation Promissory Notes

68. 9-67 On March 1, 1998, Beautiful Cosmetics purchased a copier for 10,000 from Business Machines, Inc. Beautiful Cosmetics gave Business Machines, Inc. $1,000 cash plus a 12% note due in 90 days. (Assume Business Machines, Inc. uses a periodic inventory system.) Prepare the journal entries for Beautiful Cosmetics and Business Machines, Inc. Promissory Notes Example

69. 9-68 Promissory Notes Example 10,000 GENERAL JOURNAL Page 56 DateDescription Post. Ref.DebitCredit Mar.1Notes Receivable9,000 Cash1,000 Sales To record copier sale Business Machines, Inc. 10,000

70. 9-69 Promissory Notes Example 9,000 1,000 GENERAL JOURNAL Page 34 DateDescription Post. Ref.DebitCredit Mar.1Office Equipment10,000 Notes Payable Cash To record copier purchase Beautiful Cosmetics 1,000 9,000

71. 9-70 Promissory Notes Example What is the maturity date of the note between Beautiful Cosmetics and Business Machines, Inc.?

72. 9-71 Promissory Notes Example What is the maturity date of the note between Beautiful Cosmetics and Business Machines, Inc.? Days in March31days -Note Date1 Days Outstanding in March30days +Days in April30days Days Outstanding in March/April60days +Days in May to Equal 9030days Total Life of Note90days ( PLUG )

73. 9-72 Promissory Notes Example How much total cash will Beautiful Cosmetics pay at maturity?

74. 9-73 Promissory Notes Example How much total cash will Beautiful Cosmetics pay at maturity? Interest = $9,000 × 12% × 90 / 360 Note Principal9,000$ Interest270 Total Cash Paid9,270$

75. 9-74 Promissory Notes Example How much total cash will Beautiful Cosmetics pay at maturity? Prepare the journal entries at maturity for Beautiful Cosmetics and Business Machines, Inc. Note Principal9,000$ Interest270 Total Cash Paid9,270$

76. 9-75 Promissory Notes Example 9,270 GENERAL JOURNAL Page 84 DateDescription Post. Ref.DebitCredit May30Notes Payable9,000 Interest Expense270 Cash To record note payment Beautiful Cosmetics 9,270

77. 9-76 Promissory Notes Example

78. 9-77 If a note is still outstanding at the end of the accounting period, an adjusting entry is required to record the accrued interest on both the maker’s and payee’s books. Maker’s Adjusting Entry Interest Expense Dr. Interest Payable Cr. Maker’s Adjusting Entry Interest Expense Dr. Interest Payable Cr. Accruing Interest

79. 9-78 If a note is still outstanding at the end of the accounting period, an adjusting entry is required to record the accrued interest on both the maker’s and payee’s books. Payee’s Adjusting Entry Interest Receivable Dr. Interest Revenue Cr. Payee’s Adjusting Entry Interest Receivable Dr. Interest Revenue Cr. Accruing Interest

80. 9-79 Dishonored Notes Maker... l Fails to pay amounts due at maturity. l Records Interest Expense and Interest Payable.

81. 9-80 Dishonored Notes Payee... l Transfers Note Receivable to Accounts Receivable. l Records Interest Revenue and Interest Receivable.

82. 9-81 Two Types of Promissory Notes ÊInterest-bearing u A/K/A “Straight Loan” u Interest is paid at maturity u Borrower receives cash equal to amount of note ËNoninterest-bearing u A/K/A “Discounted” note u Interest is withheld by bank up front u Borrower receives cash equal to amount of the note less interest

83. 9-82 Interest-Bearing Note (“Straight” Loan) This one is relatively simple. For example, borrower asks bank for $20,000 and receives $20,000, then makes the following journal entry: Cash 20,000 Notes Payable 20,000

84. 9-83 Non-Interest-Bearing Note (Discounted Note) l Uses a new account, Discount on Notes Payable u Is a contra-liability account u Normal balance is debit l Initial account balance is the difference between the note’s maturity value and the cash proceeds received by borrower u i.e., represents interest withheld by bank l This amount is allocated to interest expense over life of note

85. 9-84 On March 1, 1999 Hillbilly Sounds, Inc. discounted a $20,000, 6-month, non-interest-bearing note at American Bank at 9%. On Sept. 1, 1999 Hillbilly Sounds pays American Bank in full. How would these entries be recorded by Hillbilly Sounds? Non-Interest-Bearing Note Example

86. 9-85 Non-Interest-Bearing Note Example GENERAL JOURNAL Page 1 DateDescriptionPRDebitCredit 3/1/99Cash19,100 Discount on Notes Payable900 Notes Payable20,000 To record discounting of note $20,000 ×.09 × ½ = $900 bank discount

87. 9-86 GENERAL JOURNAL Page 1 DateDescriptionPRDebitCredit 3/1/99Cash19,100 Discount on Notes Payable900 Notes Payable20,000 To record discounting of note $20,000 ×.09 × ½ = $900 bank discount CONTRA-LIABILITY ACCOUNT Non-Interest-Bearing Note Example

88. 9-87 Partial Balance Sheet at March 1, 1999 Current Liabilities: Notes Payable $ 20,000 Less: Discounts on Notes Payable 90019,100 Carrying Value Non-Interest-Bearing Note Example

89. 9-88 Non-Interest-Bearing Note Example At maturity on Sept. 1, 1999, Hillbilly Sounds, Inc. pays American Bank in full. GENERAL JOURNAL Page 1 DateDescriptionPRDebitCredit 9/1/99Notes Payable20,000 Interest Expense900 Discount on Notes Payable900 Cash20,000 To record interest and note payment

90. 9-89 WE ARE SAILING RIGHT ALONG!!