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Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
Chapter 8
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Chapter 8
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Chapter 8

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  • 1. Chapter 8 Reporting andInterpreting Receivables, Bad Debt Expense, and Interest Revenue
  • 2. Learning Objectives1. Describe the trade-offs of extending credit.2. Estimate and report the effects of uncollectible accounts.3. Compute and report interest on notes receivable.4. Compute and interpret the receivables turnover ratio.
  • 3. Sales on Account When companies allow customers to purchase merchandise on an open account, the customer agrees to pay the company in the future For sales on account, credit is extended without a formal note for a short period (30 to 60 days) Although cash is not received initially, if collection is reasonably certain, sales revenue and an account receivable are recorded at the time of the sale. Advantages: Increases the seller’s revenues. Disadvantages:  Increased wage costs.  Bad debt costs.  Delayed receipt of cash.
  • 4. Accounting for Bad Debts Bad debts result from credit customers who will not pay the business the amount they owe, regardless of collection efforts.
  • 5. Accounting for Bad Debts Bad debts are likely to be discovered in periods after the credit sale. If bad debts are not reported until discovered, income is distorted in the periods of sale as well as in the period of bad debt discovery. Year 1 Year 2 (Credit Sale Occurs) (Bad Debt discovered) Revenues $ 10,000 Revenues 0 Cost of goods sold 6,000 Cost of goods sold 0 Bad debt expense 0 Bad debt expense 1,000 Net income $ 4,000 Net income $ (1,000)Can you find any problem in this example?
  • 6. Accounting for Bad Debts Bad Debt Expense Matching Record in same Principle accounting period. Sales RevenueAccounts receivable should be carried at net realizable value
  • 7. Allowance Method forUncollectible Accounts Allowance method follows a two-step process:1. It records an estimated bad debt expense in the period when the related sales take place, by making an adjusting journal entry at the end of that period.2. It removes (write off) accounts receivable in the period they are determined to be uncollectible.
  • 8. Accounting for Bad DebtsRevision of the example using Allowance Method: in Year1, suppose the firm estimated and recorded a bad debtexpense $1,000. Year 1 Year 2 (Credit Sale Occurs) (Bad Debt discovered) Revenues $ 10,000 Revenues 0 Cost of goods sold 6,000 Cost of goods sold 0 Bad debt expense 1,000 Bad debt expense - Net income $ 3,000 Net income $ -
  • 9. Recording Bad Debt Expense Estimates Timberland estimated bad debt expense for 2009 to be $2,000,000. Prepare the adjusting entry. GENERAL JOURNAL Page 78 Date Description Debit CreditDec. 31
  • 10. Recording Bad Debt Expense Estimates Timberland estimated bad debt expense for 2009 to be $2,000,000. Prepare the adjusting entry. Bad Debt Expense is normally classified as aPage 78 GENERAL JOURNAL Date selling expense and is closed at year-end. Credit Description DebitDec. 31 Bad Debt Expense (+E, -SE) 2,000,000 Allowance for Doubtful Accounts(-A) 2,000,000 Contra asset account
  • 11. Allowance for Doubtful Accounts Balance Sheet DisclosureAccounts receivable 67,000,000Less: Allowance for doubtful accounts (2,000,000)Net realizable value of accounts receivable 65,000,000 Amount the business expects to collect.
  • 12. Writing Off Uncollectible Accounts When it is clear that a specific customer’s account receivable will be uncollectible, the amount should be removed from the Accounts Receivable account and charged to the Allowance for Doubtful Accounts.
  • 13. Writing Off Uncollectible Accounts Timberland’s total write-offs for 2009 were $1,480,000. Prepare a summary journal entry for these write-offs. GENERAL JOURNAL Page 37Date Description Debit Credit
  • 14. Writing Off Uncollectible Accounts Timberland’s total write-offs for 2009 were $1,480,000. Prepare a summary journal entry for these write-offs. GENERAL JOURNAL Page 37Date Description Debit Credit Allowance for Doubtful Accounts(+A) 1,480,000 Accounts Receivable(-A) 1,480,000
  • 15. Writing Off Uncollectible Accounts Assume that before the write- off, Timberland’s Accounts Receivable balance was $81,000,000 and the Allowance for Doubtful Accounts balance was $2,000,000. Let’s see what effect the total write-offs of $1,480,000 had on these accounts.
  • 16. Writing Off Uncollectible Accounts Before Write- After Write- Off OffAccounts receivable $ 81,000,000 $ 79,520,000Less: Allow. for doubtful accts. (2,000,000) (520,000)Net realizable value $ 79,000,000 $ 79,000,000 Notice that the total write-offs of $1,480,000 did not change the net realizable value nor did it affect any income statement accounts.
  • 17. Write-off of Uncollectible Accounts Write-off of A/R deemed uncollectible DOES NOT create an expense. Write-offs decrease A/R and the Allowance for Doubtful Accounts by like amounts, therefore it DOES NOT affect the net receivable balance. There is no net effect on the total assets
  • 18. Allowance Method Recap The ADA is a contra-asset that is subtracted from accounts receivable It is “fed” with bad debt expense It is “eaten up” by account write-offs Allowance for doubtful accounts Bad debt Write- expense offs
  • 19. Summary of allowance method Step Timing Accounts F/S effects 1.Record End of Bad debts E Net Income estimated period in bad debts which sales ADA Assets adjustment are made 2. Identify Throughout Accounts R Net income (N) And write period as off actual bad debts ADA Assets (N) bad debts become known
  • 20. Methods for Estimating Bad Debts Income Statement Approach  Percent of Credit Sales Balance Sheet Approach  Aging of Accounts Receivable ????
  • 21. Percentage of Credit Sales Bad debt percentage is based on actual uncollectible accounts from prior years’ credit sales.Focus is on determining the amount to record on the income statement as Bad Debt Expense.
  • 22. Percentage of Credit Sales Net Credit Sales  % Estimated Uncollectible Amount of Journal Entry
  • 23. Percentage of Credit Sales In 2009, Kid’s Clothes had credit sales of $60,000. Past experience indicates that bad debts are one percent of credit sales. What is the estimate of bad debts expense for 2009?
  • 24. Percentage of Credit Sales In 2009, Kid’s Clothes had credit sales of $60,000. Past experience indicates that bad debts are one percent of credit sales. What is the estimate of bad debts expense for 2009? $60,000 × .01 = $600 Now, prepare the adjusting entry.
  • 25. Percentage of Credit Sales GENERAL JOURNAL Page 76 Date Description Debit CreditDec. 31 Bad Debt Expense 600 Allowance for Doubtful Accounts 600
  • 26. Methods for Estimating Bad Debts % of Sale method Net Credit Sales  % Estimated Uncollectible Amount of Journal EntryBad debt expense XXX Allowance for doubtful accounts XXX Allowance for doubtful accounts Existing BalanceAging of A/R method XXX adjustm entAccounts Receivable *% estimated uncollectible End. BalanceDesired balance in ADA
  • 27. Balance Sheet Approach 1. Determine the amount of A/R that are expected to be uncollectible 2. This is equal to the required ADA balance 3. If existing ADA balance is not high enough then increase the balance by recognizing bad debt expense Hint: Use of t-accounts is very helpful here! Allowance for doubtful accounts Existing BalanceAging of A/R method XXX adjustm entAccounts Receivable *% estimated uncollectible End. BalanceDesired balance in ADA
  • 28. Aging Schedule Each customer’s account is aged by breaking down the balance by showing the age (in number of days) of each part of the balance. An aging of accounts receivable for Kid’s Clothes in 2009 might look like this . . .
  • 29. Aging Schedule Days Past Due Total Not Yet A/RCustomer Due 1-30 31-60 61-90 Over 90 BalanceAaron, R. $ 235 $ 235Baxter, T. $ 1,200 300 1,500Clark, J. $ 50 $ 200 $ 500 750Zak, R. 325 325Total $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660 Based on past experience, the business estimates the percentage of uncollectible accounts in each time category.
  • 30. Aging Schedule Days Past Due Total Not Yet A/RCustomer Due 1-30 31-60 61-90 Over 90 BalanceAaron, R. $ 235 $ 235Baxter, T. $ 1,200 300 1,500Clark, J. $ 50 $ 200 $ 500 750Zak, R. 325 325Total $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660% Uncollectible 0.01 0.04 0.10 0.25 0.40 These percentages are then multiplied by the appropriate column totals.
  • 31. Aging of Accounts Receivable Days Past Due Record the Dec. 31, 2009, adjusting Total entry assuming that the Allowance A/R Not YetCustomer Due 1-30 31-60 61-90 Over 90 BalanceAaron, R. for Doubtful Accounts currently has $ 235 $ 235 aBaxter, T. $50 300 $ 1,200 credit balance. 1,500Clark, J. $ 50 $ 200 $ 500 750Zak, R. 325 325Total $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660% Uncollectible 0.01 0.04 0.10 0.25 0.40EstimatedUncoll. Amount $ 35 $ 102 $ 183 $ 385 $ 496 $ 1,201
  • 32. Aging of Accounts Receivable Allowance forKids clothes’ balance in the Doubtful Accountsallowance account is credit $50. 50 1,151We estimated the proper 1,201balance to be $1,201. GENERAL JOURNAL Page 76 Post. Date Description Ref. Debit Credit Dec. 31 Bad Debt Expense 1,151 Allowance for Doubtful Accounts 1,151
  • 33. Aging of Accounts Receivable What if the existing balance of ADA is debit?? Allowance for Doubtful Accounts 50 Balance at 12/31/2003 before adj. 1,251 2003 adjustment 1,201 Balance at 12/31/2003 after adj.
  • 34. Aging of Accounts Receivable Accounts Receivable  % Estimated Uncollectible Desired Balance in Allowance Account - Allowance Account Credit Balance Amount of Journal Entry Accounts Receivable  % Estimated Uncollectible Desired Balance in Allowance Account + Allowance Account Debit Balance Amount of Journal Entry
  • 35. Summary of Methods to Estimate Bad Debts Income Balance Sheet Statement Approach Approach Emphasis on Emphasis on Net Matching Realizable Value Sales Accts. Bad Rec. All. for Debts Uncoll. Exp. Accts. Income Balance Sheet Statement Focus Focus
  • 36. Recovery of a Bad Debt Subsequent collections on accounts written off require that the original write-off entry be reversed before the cash collection is recorded. DR CRFeb. 8 Accounts Receivable - Martin 300 Allowance for Doubtful Accounts 300 To reinstate account previously written offFeb. 8 Cash 300 Accounts Receivable - Martin 300 To record full payment on account
  • 37. Notes Receivable Accounts receivable do not charge interest until they become overdue, but notes A note is a receivable start charging written interest the day they are created. promise to pay a specific amount at a specific future date.
  • 38. Notes Receivable Term$1,000.00 July 10, 2007 Payee Ninety days after date I promise to pay tothe order of Barton Company, Los Angeles, CAOne thousand and no/100 --------------------------------- DollarsPayable at First National Bank of Los Angeles, CA MakerValue received with interest at 12% per annumNo. 42 Due Oct. 8, 2007 Julia Browne
  • 39. Notes Receivable$1,000.00 July 10, 2007 Ninety days after date I promise to pay tothePrincipal Barton Company, Los Angeles, CA order ofOne thousand and no/100 --------------------------------- DollarsPayable at First National Bank of Los Angeles, CA Interest RateValue received with interest at 12% per annumNo. 42 Due Oct. 8, 2007 Julia Browne Due Date
  • 40. Interest Computation Interest is the compensation to the lender for giving up the use of money for a period of time. To the lender, interest is a revenue. To the borrower, interest is an expense.
  • 41. Interest (less than one year) ComputationPrincipal Annual Time of the × interest × expressed = Interest note rate in years Even for Number of maturities less months out of than one year, twelve the rate is that interest annualized. period covers.
  • 42. Computing Maturity and Interest On March 1, 2009, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due on May 30, 2009 in payment for the copier.
  • 43. Computing Maturity and InterestPrincipal Annual Time of the × interest × expressed = Interest note rate in years$ 12,000 × 9% × 3/12 = $ 270 Total interest due at May 30.
  • 44. Recognizing Notes Receivable Here are the entries to record the note on March 1, and the settlement on May 30, 2009. DR CRMar. 1 Notes Receivable 12,000 Sales 12,000 Sold goods in exchange for note DR CRMay 30 Cash 12,270 Interest Revenue 270 Notes Receivable 12,000 Collected note and interest due
  • 45. Recording End-of-Period InterestAdjustments When a note receivable is outstanding at the end of an accounting period, the company must prepare an adjusting entry to accrue interest income.
  • 46. Reporting Interest on Notes Receivable On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008. Record Record interest note Accrue and principalreceivable interest received 2007 Interest 2008 Interest11/01/07 12/31/07 10/31/08
  • 47. Recording Notes Receivable on Nov. 1On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.On November 1, to record the note: Accounts Debit Credit Note Receivable (+A) 100,000 Cash (-A) 100,000
  • 48. Accruing Interest Earned at fiscal yearend (12/31/2007) $ 100,000 12% 2/ = $ 2,000 × × 12On December 31, to accrue $ 2,000 interest receivable: Accounts Debit CreditInterest Receivable (+A) 2,000 Interest Revenue (+R, +SE) 2,000
  • 49. Recording Interest Received and Principal at Oct 31, 2008On October 31, to record $112,000 cash received: $100,000 principal (note receivable) $2,000 interest receivable (2007 interest revenue) $100,000 x 12% x 10/12 = $10,000 (2008 interest revenue) Accounts Debit Credit Cash (+A) 112,000 Interest Revenue (+R, +SE) 10,000 Interest Receivable (-A) 2,000 Note receivable (-A) 100,000
  • 50. Quick check On July 1, Barton Co. received a $1,000, 3 months, 10% note in exchange for merchandise sold to a customer (the merchandise cost was $600). Perpetual inventory system. Notes receivable $1,000 Sales revenue $1,000 Cost of Goods sold $600 Inventory $600 On Sep 30, the customer paid interest and principal on the note. $1,000 × 10% × 3/12 = $25 Cash $1,025 Interest revenue $25 Notes receivable $1,000
  • 51.  On Nov 1, received $2,000 cash plus a one year, 12 %, $10,000 note from another customer in exchange for merchandise (its cost was $8,000). Cash $2,000 Notes receivable $10,000 Sales revenue $12,000 Cost of Goods sold $8,000 Inventory $8,000 On Dec 31, prepare the adjusting entry for the above note $10,000 × 12% × 2/12 = $200 Interest receivable $200 Interest revenue $200 On Oct 31 of the next year, received interest and principal on the note. Cash $11,200 Interest revenue $1,000 Interest receivable $200 Notes receivable $10,000
  • 52. Accounts Receivable Turnover Accounts Net Sales Receivable = Average Net Accounts Receivables Turnover This ratio measures how many times average receivables are recorded and collected for the year.
  • 53. Accounts Receivable TurnoverReceivable Net Sales Turnover = Average Net Accounts ReceivablesReceivable $1,091,478,000 = Turnover ($105,727,000 + $78,696,000) ÷ 2 = 11.8 times Timberland reported 2008 net sales of $1,091,478,000.December 31, 2007, net receivables were $78,696,000 and December 31, 2008, net receivables were $105,727,000.
  • 54. In-class problem #1At the start of 2009, Accounts receivable showed a $35,000 debit balance, and the Allowance for doubtful accounts showed an $1,000 credit balance. During the year of 2009, the firm had sales revenue of $200,000, of which $100,000 was on credit. Collections of accounts receivable during 2009 amounted to $88,000.(a) On April 5, 2009, a customer balance of $1,500 from a prior year was determined to be uncollectible, so it was written off.(b) On December 31, 2009, the firm estimated bad debt expense for 2009 to be $2,000.Give the required journal entries for the two events, Show how the amounts related to Accounts receivable and Bad debt expense would be reported on the balance sheet and income statement for 2009.
  • 55. In class problem #2Barton’s year-end unadjusted trial balance shows accounts receivable of $1,000, allowance for doubtful accounts of $6 (debit), and credit sales of $2,000, uncollectibles are estimated to be 1% of credit sales. Prepare the year-end adjust entry for uncollectibles. Show the A/R accounts in B/S.
  • 56. In-class problem #3Suppose the beginning balance of A/R is $55,000, and ADA is $290 (credit). Assuming Perpetual inventory system. During the period. Writes off a $750 account receivable arise from a sale to Briggs Co. the dates to 10 months ago. Received the full amount of $750 from Briggs Co. that was previously written off. Collected cash $5,250 from A/R. Sold $7,000 of merchandise to customers on credit, which cost the firm $4,000.In the end of the period, the company estimated 1% of accounts receivable bill be uncollectible.Give the required journal entries and show how the Accounts receivable and Bad debt expense would be reported on the balance sheet and income statement.
  • 57. In-class problem #4Q1) The unadjusted balance of the allowance for doubtful accounts of Johnstone Supplies, Inc., is a credit balance in the amount of $20,000 on July 31, 2005, its fiscal year end. Assuming that Johnstone uses the accounts receivable aging report, prepare the adjusting journal entry to report bad expense.Q2) August 5, 2005: YOC corporation, Johnstone’s customer, filed bankruptcy. Accordingly, Johnston writes off $10,000 account receivable from YOC. Prepare a journal entry to record the account receivable write-off.Q3) October 15, 2005: Based on the bankruptcy court’s decision, Johnstone collects $5,000 accounts receivable from YOC that they previously wrote off. Prepare a journal entry to record the recovery of the accounts receivable.

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