John Wiley & Sons, Inc. Financial A ccounting, 5e Prepared by Kurt M. Hull, MBA CPA California State University, Los Angeles Weygandt, Kieso, & Kimmel
CHAPTER 9 ACCOUNTING FOR RECEIVABLES STUDY OBJECTIVES After studying this chapter, you should understand: Types of receivables Disposition of A/R Valuation of N/R Recognition of A/R Maturity & Interest of N/R Disposition of N/R Valuation of A/R Recognition of N/R F/S Presentation & Analysis
STUDY OBJECTIVE 1 TYPES OF RECEIVABLES Receivables are amounts due from individuals and other companies. There are three major classes of receivables: A/R N/R Other Owed by customers on account, from credit sales, due in 30-60 days. Claims supported by a formal credit instrument. Due in 60-90 days, with interest. Loans to company officers, employee advances, refundable income taxes.
STUDY OBJECTIVE 2 RECOGNIZING A/R A classic general journal sequence for credit sales. Date Description Debit Credit July 1 A/R—Polo Company 1000 Sales 1000 (sales on account) July 5 Sales returns & allowances 100 A/R—Polo Company 100 (merchandise returned ) July 11 Cash 882 Sales Discounts 18 A/R—Polo Company 900 (collection of A/R)
<ul><li>Receivables are current assets on the balance sheet </li></ul><ul><li>They are stated at net realizable value, the amount expected to be received in cash. </li></ul><ul><li>Uncollectible A/R are accounted for using two methods </li></ul>STUDY OBJECTIVE 3 VALUATION OF A/R Direct Write-Off Method Allowance Method
<ul><li>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. </li></ul><ul><li>Bad debt expense shows only actual losses. </li></ul><ul><li>Not acceptable for financial reporting purposes unless losses are insignificant. </li></ul>DIRECT WRITE-OFF METHOD Bad debts expense Operating expense on the income statement
Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles. Date Account Titles Debit Credit General Journal Dec. 12 Bad Debts Expense 200 Accounts Receivable – M.E. Doran 200 DIRECT WRITE-OFF METHOD
<ul><li>The allowance method is required when bad debts are material. </li></ul><ul><li>Uncollectible accounts are estimated </li></ul><ul><li>The expense is matched against sales in the same accounting period. </li></ul>ALLOWANCE METHOD Uncollectible accounts expense = bad debts expense
Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts at the end of each period. Date Account Titles Debit Credit General Journal Dec. 31 Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000 ALLOWANCE METHOD RECORDING ESTIMATED UNCOLLECTIBLES
Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off. Date Account Titles Debit Credit General Journal Mar. 1 Allowance for Doubtful Accounts 500 Accounts Receivable - R. A. Ware 500 ALLOWANCE METHOD RECORDING A WRITE-OFF
To recover an account that has been written off: 1 reverse the write-off entry. Date Account Titles Debit Credit General Journal July 1 Accounts Receivable – R. A. Ware 500 Allowance for Doubtful Accounts 500 ALLOWANCE METHOD RECORDING A RECOVERY Date Account Titles Debit Credit General Journal July 1 Cash 500 Accounts Receivable 500 2 record the collection in the usual manner.
Percentage of Sales Percentage of Receivables Emphasis on Income Statement Relationships Emphasis on Balance Sheet Relationships ALLOWANCE METHOD BASIS FOR ESTIMATING UNCOLLECTIBLES Two methods of estimating uncollectible accounts comply with GAAP. Uses aging schedule
<ul><li>Bad debt expense is based on a % of current credit sales estimated to be uncollectible, based on past experience. </li></ul><ul><li>Matches expenses with revenues. </li></ul><ul><li>No consideration given to existing balance in the allowance. </li></ul>ALLOWANCE METHOD PERECENTAGE OF SALES BASIS If net credit sales for the year are $800,000, the estimated bad debts expense is $8,000 (1% X $800,000). Dec. 1 Bad Debts Expense 8,000 Allowance for Doubtful Accounts 8,000
<ul><li>Bad debt expense based on % of the ending balance in A/R. </li></ul><ul><li>The adjusting entry is the difference between the required balance and the existing balance in the allowance account. </li></ul><ul><li>Estimates NRV of receivables. </li></ul>ALLOWANCE METHOD PERECENTAGE OF RECEIVABLES BASIS Date Account Titles Debit Credit General Journal Dec. 1 Bad Debts Expense 1,700 Allowance for Doubtful Accounts 1,700 If the trial balance shows Allowance for Doubtful Accounts with a credit balance of $528, an adjusting entry for $,1,700 ($2,228 - $528) is necessary.
<ul><li>Which of the following approaches for bad debts </li></ul><ul><li>is referred to as a balance sheet method? </li></ul><ul><li>Percentage of receivables method </li></ul><ul><li>Direct write-off method </li></ul><ul><li>Percentage of sales method </li></ul><ul><li>Both a and b </li></ul>REVIEW QUESTION Answer: (A) Percentage of receivables method .
STUDY OBJECTIVE 4 DISPOSING OF A/R Two ways to dispose of A/R Factoring Credit card sales
Henderson Furniture factors $600,000 of receivables to Federal Factors, Inc. Federal Factors assesses a 2% service charge. Date Account Titles Debit Credit General Journal Cash 588,000 Service Charge Expense (2% x $600,000) 12,000 Accounts Receivable 600,000 DISPOSING OF A/R FACTORING (SALE) OF RECEIVABLES A factor is a finance company that buys A/R from companies, then collects payments directly from the customers.
<ul><li>Three parties are involved with credit card sales: </li></ul><ul><li>The retailer pays the credit card issuer </li></ul><ul><li>a fee of 2-6% of the invoice price. </li></ul><ul><li>Sales from Visa, MasterCard, and Discover are treated </li></ul><ul><li>differently than American Express & Diners Club </li></ul>CREDIT CARD SALES Credit card issuer Retailer Customer
<ul><li>Considered cash sales by the retailer. </li></ul><ul><li>Upon receipt of credit card sales slips from a retailer, the bank adds the amount to the seller’s bank balance. </li></ul>VISA, MASTERCARD, & DISCOVER Date Account Titles Debit Credit General Journal Cash 970 Service Charge Expense 30 Sales 1,000 Barbara Hardy purchases CD’s for her restaurant from Ty Parker Music Co. for $1,000 using her VISA First Bank Card. First Bank charges a 3% fee.
<ul><li>Considered credit sales by the retailer. </li></ul><ul><li>Conversion into cash does not occur until the companies remits the net amount to the seller. </li></ul>AMERICAN EXPRESS & DINERS CLUB Date Account Titles Debit Credit General Journal Accounts Receivable – American Express 285 Service Charge Expense 15 Sales 300 Four Seasons for her restaurant from Karen Kerr Music Co. for $1,000 using her VISA First Bank Card. The service fee that First Bank charges is 3%.
<ul><li>A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. </li></ul><ul><li>The party making the promise is the maker. </li></ul><ul><li>The party to receive payment is the payee. </li></ul>PROMISSORY NOTES
<ul><li>When the life of the note is expressed in terms of days , you need to count the days. </li></ul><ul><li>In counting, the date of issue is omitted but the due date is included . </li></ul><ul><li>Example: The maturity date of a 60-day note dated July 17 is: </li></ul>STUDY OBJECTIVE 5 MATURITY & INTEREST – NOTES RECEIVABLE Term of note 60 days July (31-17) -14 days August -31days Maturity date: September 15
The formula for computing interest on an interest-bearing note is: The interest rate specified on the note is an annual rate of interest. X X = COMPUTING INTEREST Face Value of Note Annual Interest Rate Time in Terms of One Year Interest
<ul><li>$ 730 X 18% X 120/360 = $ 43.80 $1,000 X 15% X 6/12 = $ 75.00 $2,000 X 12% X 1/1 = $240.00 </li></ul>COMPUTATION OF INTEREST The interest rate specified is the annual rate.
<ul><li>Compute the missing amount below: </li></ul>REVIEW QUESTION $450 120 days 9% ? Total Interest Time Annual Interest Rate Face Value I = P x R x T (face value = principal) $450 = P x .09 x 120/360 P = $15,000
Wilma Company receives a $1,000, 2-month, 12% promissory note from Brent Company to settle an open account. Date Account Titles Debit Credit General Journal May 1 Notes Receivable 1,000 Accounts Receivable – Brent Company 1,000 STUDY OBJECTIVE 6 RECOGNIZING NOTES RECEIVABLE Notes receivable are recorded at FACE VALUE
<ul><li>N/R are recorded at face value. </li></ul><ul><li>Allowance for Doubtful Accounts used to record estimated uncollectible accounts. </li></ul><ul><li>N/R reported on the balance sheet at net realizable value. </li></ul>STUDY OBJECTIVE 7 VALUATION OF NOTES RECEIVABLE Gross N/R – Allowance = Net Realizable Value
Betty Co. lends Higley Inc. $10,000 on June 1, accepting a 5-month, 9% interest-bearing note. Betty collects the maturity value of the note from Higley on Nov 1. STUDY OBJECTIVE 8 DISPOSING OF NOTES RECEIVABLE HONORED NOTE A note is honored when it is paid in full at its maturity date. For an interest-bearing note, the maturity amount is the face value plus interest. Date Account Titles Debit Credit Nov 1 Cash 10,375 Notes Receivable 10,000 Interest Revenue 375 (collection of Higley, Inc. note)
If Betty Co. prepares prepares financial statements on September 30, interest for 4 months, would be accrued. ACCRUING INTEREST -- HONORED NOTE RECEIVABLE Interest receivable is a current asset Date Account Titles Debit Credit Sept 30 Interest Receivable ($10,000 x 9% x 4/12) 300 Interest Revenue 300 (accrue 4 month’s interest on Higley, Inc. note)
When interest has been accrued, it is necessary to credit Interest Receivable at maturity. ACCRUING INTEREST -- HONORED NOTE RECEIVABLE Date Account Titles Debit Credit Nov 1 Cash 10,375 Notes Receivable 10,000 Interest Receivable 300 Interest Revenue 75 (collection of note at maturity)
A dishonored note is a note that is not paid in full at maturity. Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable. DISHONOR OF NOTE RECEIVABLE NOTE: This scenario assumes the note will eventually be collected. Date Account Titles Debit Credit Nov 1 A/R—Higley, Inc. 10,375 Notes Receivable 10,000 Interest Revenue 375 (record dishonor of Higley note)
DISHONOR OF NOTE RECEIVABLE If there is no hope of collection, The face value eliminated, and the allowance is debited. Also, no interest would be accrued. Date Account Titles Debit Credit Nov 1 Allowance for doubtful accounts 10,000 Notes Receivable 10,000 (record dishonor of Higley note)
<ul><li>In the balance sheet, short-term receivables are reported in the current assets section below short-term investments. </li></ul><ul><li>Report both the gross amount of receivables and the allowance for doubtful accounts. </li></ul>STUDY OBJECTIVE 9 FINANCIAL STATEMENT PRESENTATION & ANALYSIS Accounts receivable $1,200,000 Less: allowance for doubtful accounts (48,000) Accounts receivable, net $1,152,000
<ul><li>Financial ratios are computed to evaluate the liquidity of a company’s accounts receivable. </li></ul><ul><li>The accounts receivables turnover ratio is used to assess the liquidity of the receivables. </li></ul><ul><li>The data below is from Cisco Systems: </li></ul>/ = A/R TURNOVER RATIO <ul><ul><li>$18,878 / ( $1,105 + $1,351)/2 = 15.4 times </li></ul></ul>Net Credit Sales Average Net Receivables Accounts Receivable Turnover
<ul><li>The average collection period in days is a variant of the turnover ratio that makes liquidity even more evident. </li></ul><ul><li>This is done by dividing the turnover ratio into 365 days. </li></ul><ul><li>The general rule is that the collection period should not exceed the credit term period. </li></ul><ul><li>Cisco System’s turnover ratio is computed as: </li></ul>/ = AVERAGE COLLECTION PERIOD Days in year A/R Turn Ratio Average Collection Period 365 / 15.4 23.7 days