Accounts and Notes Receivable

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Accounts and Notes Receivable

• Chapter 8

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Receivables
Accounts receivable
Notes receivable
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Objective 1

• Design internal controls
• for receivables.

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Establishing Internal Control

• What are some controls over accounts receivable?

Control over mail receipts
Approval for write-off
Separation of duties
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The Credit Department

• Companies grant credit to customers in order to
  increase sales.
• The credit department evaluates customers who
  apply for credit cards.

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Uncollectible Accounts Expense
Allowance method
Direct write-off method
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Objective 2

• Use the allowance method
• to account for uncollectibles
• and estimate uncollectibles
• by the percent of sales
• and aging approaches.

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Methods for Estimating Uncollectible Expense
Percentage of Sales
Aging of Receivables
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Percentage of Sales

• This is also called the income statement
  approach.
• It is based on prior experience of the business.
• It is computed as a percentage of credit sales.
• It ignores the current balance of the allowance
  account.
• The percentage used is adjusted as needed to
  reflect collection experience.

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Percentage of Sales Example

• The credit department of Anas Boutique estimates
  (based on prior experience) that 1 of net credit
  sales are uncollectible.
• Net credit sales for the year just ended were
  500,000.
• What is the adjusting entry?
• 500,000 1 5,000

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Percentage of Sales Example

• Dec 31, 200x
• Uncollectible Account Expense 5,000
• Allowance for Uncollectible Accounts 5,000
• Recorded expense for the year

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Percentage of Sales Example
What is the effect of this adjusting entry?
Decrease in Net Income
Decrease in net Accounts Receivable
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Aging of Accounts Receivable

• This approach is also called the balance sheet
  approach because it focuses on accounts
  receivable.
• Individual accounts receivable from specific
  customers are analyzed according to the length of
  time they remain outstanding.

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Aging of Receivables Example

• Assume that International Hospitals past
  collection experience indicates the following
• Length of time uncollectible
  1-30 days 2.0
  31-60 days 3.0
  61-90 days 5.0
  90 days 8.0

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Aging of Receivables Example

• Length Amount
• 1-30 1,900,000 2 38,000
• 31-60 1,000,000 3 30,000
• 61-90 700,000 5 35,000
• 90 500,000 8 40,000
• Total 4,100,000 143,000

Accounts Receivable
Allowance for Uncollectible Accounts
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Aging of Receivables Example

• The allowance account is adjusted to this
  143,000 balance
• Assume that the account currently has a credit
  balance of 100,000.
• What is the adjustment?

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Aging of Receivables
Uncollectible Account
Expense
43,000 Allowance for Uncollectible
Accounts
43,000 To record allowance for uncollectibles
What if the account had a debit balance of 1,000?
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Aging of Receivables

• Allowance for Uncollectible
• Adjustment
• 1,000 144,000
• Adjusted balance 143,000

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Comparing the Percentage of Sales and Aging
Methods
Allowance Method
Percent of Sales Method
Aging of Accounts Receivable Method
Adjusts Allowance for Uncollectible Accounts
Adjusts Allowance for Uncollectible Accounts
BY
TO
Amount of
Amount of
UNCOLLECTIBLE ACCOUNT EXPENSE
UNCOLLECTIBLE ACCOUNTS RECEIVABLE
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Writing OffUncollectible Accounts

• What happens when it becomes apparent that an
  account will not be collected?
• It must be written off.
• How?
• Debit Allowance for Uncollectible Accounts.
• Credit Accounts Receivable.

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Recoveries

• How is the collection of a previously written-
  off account recorded?
• Debit Accounts Receivable (to reinstate the
  account).
• Credit Allowance for Uncollectible Accounts.
• Debit Cash.
• Credit Accounts Receivable (to record the
  collection).

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Objective 3

• Use the direct write-off method
• to account for uncollectibles.

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Direct Write-Off Method

• Using this method, an account is written off
  only when it becomes uncollectible.
• No allowance account is created.
• This method is simple to use.
• The balance sheet is overstated.
• The income statement is understated.

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Credit Card and Bankcard Sales

• These save retailers the cost of a credit
  department.
• The retailer is required to pay a fee (called
  a discount) for usage.

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Credit Card and Bankcard Sales

• How would Anas Boutique record a 100 credit
  card sale with a 2 service charge?

Accounts Receivable (credit card) 98 Credit Card
Discount 2 Sales Revenue 100 T
o record a credit card sale of 100 less a 2
service charge fee
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Debit Card Sales
Using a debit card is like paying with cash.
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Notes Receivable an Overview

• A note receivable may arise from a sale or may be
  given in settlement of an account receivable.
• The maker pays the payee the maturity value.
• The maturity value includes principal plus
  interest.

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Notes Receivable an Overview

• Promissory Note
• 10,000.00
  Nov. 30, 2001
• For value received, I promise to pay to the
  order of
• POPULAR BANK
• HOUSTON, TEXAS
• TEN THOUSAND AND NO/100DOLLARS
• ON FEBRUARY 28, 2002
• Plus interest at the annual rate of 10
  percent.
• __________

Maker
Payee
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Notes Receivable an Overview

• Promissory Note
• 10,000.00
  Nov. 30, 2001
• For value received, I promise to pay to the
  order of
• POPULAR BANK
• HOUSTON, TEXAS
• TEN THOUSAND AND NO/100DOLLARS
• ON FEBRUARY 28, 2002
• Plus interest at the annual rate of 10
  percent.
• __________

Principal
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Notes Receivable an Overview

• Promissory Note
• 10,000.00
  Nov. 30, 2001
• For value received, I promise to pay to the
  order of
• POPULAR BANK
• HOUSTON, TEXAS
• TEN THOUSAND AND NO/100DOLLARS
• ON FEBRUARY 28, 2002
• Plus interest at the annual rate of 10
  percent.
• __________

Date of issue
Interest rate
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Notes Receivable an Overview

• Promissory Note
• 10,000.00
  Nov. 30, 2001
• For value received, I promise to pay to the
  order of
• POPULAR BANK
• HOUSTON, TEXAS
• TEN THOUSAND AND NO/100DOLLARS
• ON FEBRUARY 28, 2002
• Plus interest at the annual rate of 10
  percent.
• __________

Maturity date
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Identifying a NotesMaturity Date

• When the period is given in days
• the maturity date is determined by counting the
  days from the date of issue.
• The date the note was issued is omitted.
• The maturity date is counted.

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Computing Interest on a Note
Principal Rate Time Interest
Compute interest on the note due to Popular
Bank. Principal 10,000 Interest 10 Time Decem
ber 1, 2001, to February 28, 2002
10,000 10 90 360 250
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Objective 4

• Account for notes receivable.

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Recording Notes Receivable

• Assume the accounting period ended December 31.
• How much interest was earned by the bank as of
  December 31?
• 10,000 10 (31 360) 86.11

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Recording Notes Receivable

• December 31
• Interest Receivable 86.11
• Interest Revenue 86.11
• To accrue interest on the note

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Recording Notes Receivable

• How does the bank record the collection at
  maturity?

February 28 Cash 10,250.00 Note
Receivable 10,000.00 Interest
Receivable 86.11 Interest
Revenue 163.89 Record interest on note
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Dishonored Notes Receivable

• If the maker of the note fails to pay the
  maturity value to the new payee, then the
  original payee legally must pay the bank the
  amount due.

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Objective 5

• Report receivables
• on the balance sheet.

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Reporting Receivables

• Some companies report a single amount for its
  current receivables in the body of the balance
  sheet.
• They use a note to the financial statements to
  give more details.

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Objective 6

• Use the acid-test ratio and days
• sales in receivables to evaluate
• a companys financial position.

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Acid-Test Ratio

• This is a stringent test of liquidity.
• It measures the entitys ability to pay its
  current liabilities immediately.

Acid-test ratio (Cash Short-term
investments Net current receivables) Total
current liabilities
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Days Sales in Receivables

• It is a measure of the time it takes to collect
  receivables.
• A smaller number indicates a quick conversion to
  cash.

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Days Sales in Receivables
One days sales Net sales 365 days
Days sales in average accounts receivable
Average net accounts receivable One days
sales
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End of Chapter 8