Merchandising Operations and the MultipleStep Income Statement

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Chapter 8
REPORTING AND ANALYZING RECEIVABLES
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Chapter 8Reporting and Analyzing Receivables

• Identify the different types of receivables.
• Describe the methods used to account for bad
  debts.
• Compute the interest on notes receivable.
• Describe the entries to record the disposition of
  notes receivable.
• Explain the statement presentation of receivables.

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TYPES OF RECEIVABLES

• Amounts due from individuals and other
  companies-expected to be collected in cash
• Three major classes of receivables
• Accounts Receivable - amounts owed by customers
  on account, expected to be collected within 30-60
  days
• Notes Receivable - claims for which formal
  instruments of credit are issued
• Other Receivables - non-trade receivables, for
  example, interest receivable and advances to
  employees

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Accounts Receivable...

• Amounts owed by customers on account.
• Result from the sale of goods/services.
• Expected to be collected within 30-60 days.
• Most significant type of claim held by company.
• Often called trade receivables.

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ACCOUNTS RECEIVABLE

• Two accounting issues associated with accounts
  receivable
• Recognizing accounts receivable.
• Valuing accounts receivable.

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RECOGNIZING ACCOUNTS RECEIVABLE
July 1 Accounts Receivable Polo
Company 1,000 Sales
1,000
When a business sells merchandise to a customer
on credit, Accounts Receivable is debited
(increased) and Sales is credited (increased).
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RECOGNIZING ACCOUNTS RECEIVABLE
July 5 Sales Returns and Allowances
100 Accounts
Receivable Polo Company
100
When a business receives returned merchandise
previously sold to a customer on credit, Sales
Returns and Allowances is debited and Accounts
Receivable is credited (decreased).
When a business sells merchandise to a customer
on credit, Accounts Receivable is debited and
Sales is credited.
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ACCOUNTING FOR BAD DEBTS

• Receivables are valued at the net amount expected
  to be received in cash
• Excludes amounts that the company estimates it
  will not be able to collect (net realizable
  value)
• Credit losses
• Recorded as Bad Debts Expense
• Considered a normal and necessary risk of doing
  business

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2 Methods for Accounting for Uncollectible
Accounts

• The Direct Write-off Method
• The Allowance Method

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Direct Write-Off Method

• Bad debt losses are not estimated.
• No allowance account is used.
• Accounts are written off when determined
  uncollectible as follows
• Bad Debts Expense 200
• Accounts Receivable--M. E. Doran 200

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DIRECT WRITE-OFF METHOD

• Direct write-off method
• An entry is made for bad debts expense when an
  account is determined to be uncollectible at
  which time the loss is charged to Bad Debts
  Expense
• No matching of bad debts expense with the sales
  revenue
• Accounts receivable are reported at their gross
  amount on the balance sheet.
• Not acceptable for financial reporting purposes.

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THE ALLOWANCE METHOD

• Allowance method
• Required when bad debts are deemed to be material
  in amount
• Uncollectible accounts are estimated
• At the end of each period
• Expense for the uncollectible accounts is
• Matched against sales in the same accounting
  period in which the sales occurred
• Results in Receivables being stated at cash (net)
  realizable value

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THE ALLOWANCE METHOD
Dec. 31 Bad Debts Expense 12,000
Allowance for Doubtful Accounts 12,000
Estimated uncollectibles are debited to Bad Debts
Expense and credited to Allowance for Doubtful
Accounts at the end of each period.
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THE ALLOWANCE METHOD
Mar. 1 Allowance for Doubtful Accounts
500 Accounts Receivable - R.
A. Ware 500
Actual uncollectibles are debited to Allowance
for Doubtful Accounts and credited to Accounts
Receivable at the time the specific account is
written off.
General Ledger Balances after Write-off
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Recovery of Uncollectible Accounts
When there is recovery of an account that has
been written off reverse the entry made to
write off the account and...
Record the collection in the usual manner.
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Aging of Accounts Receivable

• The analysis of customer balances by the length
  of time they have been unpaid. The longer a debt
  is outstanding
  the less likely it
  is to
  be paid.

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AGING SCHEDULE
The older the accounts, the less likely to be paid
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Notes Receivable...
Credit which is extended by use of a formal
instrument.

• Credit instrument normally requires
• payment of interest
• extends for time periods of 60-90 days or longer.
• Give the holder a stronger legal claim than the
  other receivables.
• Can be sold to another party.

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FORMULA FOR COMPUTING INTEREST
The basic formula for computing interest on an
interest-bearing note is











The interest rate specified on the note is an
annual rate of interest.
COMPUTATION OF INTEREST
Illustration 8-11
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RECOGNIZING NOTES RECEIVABLE
Wilma Company receives a 1,000, 2-month, 12
promissory note from Brent Company to settle an
open account.
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VALUING NOTES RECEIVABLE

• Like accounts receivable, short-term notes
  receivable are reported at their cash (net)
  realizable value.
• The notes receivable allowance
  account is Allowance for
  Doubtful Accounts.

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DISPOSING OF NOTES RECEIVABLE

• Notes may be held to their maturity (honored)
• Face amount plus interest is received
• Notes may be sold
• To speed up the collection of cash
• Maker of the note may default
• Note is dishonored

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HONOR OF NOTES RECEIVABLE

• A note is honored when it is paid in full at its
  maturity date.
• For an interest-bearing note, the amount due at
  maturity is the face value of the note plus
  interest for the length of time specified on the
  note.
• Wolder Co. lends Higley Inc. 10,000 on June
  1, accepting a 5-month, 9 interest-bearing
  note.
• Wolder Co. collects the maturity value of the
  note from Higley on November 1.

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HONOR OF NOTES RECEIVABLE
If Wolder Co. prepares prepares financial
statements as of September 30, interest for 4
months, or 300, would be accrued.
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DISHONOR OF NOTES RECEIVABLE
Accounts Receivable
10, 375
Nov 1
10, 000
Notes Receivable
300
Interest Receivable
Interest Revenue
75

• A dishonored note is a note that is not paid in
  full at maturity.
• A dishonored note receivable is no longer
  negotiable.
• Since the payee still has a claim against the
  maker of the note, the balance in Notes
  Receivable is usually transferred to Accounts
  Receivable.

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BALANCE SHEET PRESENTATION OF RECEIVABLES
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EVALUTING LIQUIDITY OF RECEIVABLES

• Ratios are computed to evaluate the liquidity of
  a companys accounts receivable.
• How quickly the asset can be converted to cash
• Accounts receivables turnover ratio is used to
  assess the liquidity of the receivables.
• Average collection period is also used to assess
  liquidity
• A rule of thumb is that the average collection
  period should not exceed the credit term period.

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Receivables Turnover Ratio

• Net Credit Sales
• Average Net Receivables

Is a measure of the liquidity of receivables.
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Average Collection Period

• 365 days
• Receivables Turnover Ratio

Is the average amount of time that a receivable
is outstanding
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ACCELERATING CASH RECEIPTS

• Companies frequently sell their receivables to
  another company to shorten their cash-to-cash
  cycle
• Reasons for selling receivables
• Size of receivables, large amounts of cash are
  tied up
• Receivables may be the only reasonable source of
  cash
• Billing and collecting are time consuming and
  costly

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SALE OF RECEIVABLES TO A FACTOR
Hendrendon Furniture factors 600,000 of
receivables to Federal Factors, Inc. Federal
Factors assesses a service charge of 2 of the
amount of receivables sold.
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CREDIT CARD SALES

• Credit cards
• Used by retailers who wish to avoid the paperwork
  of issuing credit
• Cash is received quickly from the credit card
  issuer
• National credit cards
• Visa, MasterCard, Discover, and American Express

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VISA, MASTERCARD, AND DISCOVER SALES
Morgan Marie purchases a number of compact discs
for her restaurant from Sondgeroth Music Co. for
1,000 using her VISA First Bank Card. The
service fee that First Bank charges is 3.