Accounting for Receivables

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ACCOUTING 102
Chapter 8
Reporting Analyzing Receivables
Write-off
Professor Walsh Providence College
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Reporting Analyzing Receivables
After studying this chapter, you should be able
to

• Identify the different types of receivables.
• Explain how accounts receivable are recognized in
  the accounts.
• 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.
• Describe the principles of sound accounts
  receivable management.
• Identify ratios to analyze a companys
  receivables.
• Describe methods to accelerate the receipt of
  cash from receivables.

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RECEIVABLES

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

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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 (AR)
July 1 Accounts Receivable Polo
Company 1,000 Sales
1,000
Assuming that the Cost of Goods Sold is 600what
entry would be made on July 1st?
July 5 Sales Returns and Allowances
100 Accounts
Receivable Polo Company
100
Why do you know is this an Allowance not a Return?
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ACCOUNTING FOR BAD DEBTS

• Receivables are valued at the NET AMOUNT
• The net amount is what is expected to be received
  in cash (cash realizable value). This EXCLUDES
  amts that the co est. it will NOT be able to
  collect
• Credit losses
• considered a normal necessary risk of doing
  business
• debited to Bad Debts Expense
• Credit??
• 2 methods of accting for uncollectible accounts
• Direct write-off method
• Allowance method

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1. 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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EFFECTS OF DIRECT WRITE-OFF METHOD
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2. 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 estimated cash
  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.
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THE ALLOWANCE METHOD
When there is recovery of an account that has
been written off reverse the entry made to
write off the account and...
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THE ALLOWANCE METHOD
Record the collection in the usual manner.
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Allowance Method

• Allowance for doubtful accounts is not closed at
  the end of the year
• Bad debt expense is NOT recorded when an actual
  write-off occurs
• it has been previously estimated recorded
• A write-off of accounts receivable affects only
  BS accounts
• A recovery of accounts receivable affects only BS
  accounts

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ESTIMATING THE ALLOWANCE

• Cos frequently use the percentage of
  receivables basis to estimate the allowance
• An aging schedule is often used
• Accounts are arranged by age
• Expected bad debt losses are determined by
  applying percentages, based on experience, to
  totals for each category
• Amount of the adjusting entry is the difference
  between the required balance the existing
  balance in the allowance account

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AGING SCHEDULE
may vary company to company
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Uncollectibles

• The total estimated uncollectible accts for the
  co is 2,228
• That is, 2,228 represent the existing customer
  claims that are NOT expected to be collectible
  ALLOWANCE for doubtful accounts on BS
• Accordingly, the amt of bad debt expense
  adjusting entry diff between the req bal the
  existing bal in the allowance account.

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Okay heres the situation

• Currently there is 528 (credit) in the Allowance
  for Doubtful Accounts acct.
• Mgt. has estimated that 2,228 of the AR is
  uncollectible.
• Adjustment 2,228 528 1,700
• Bad debt exp 1,700
• Allowance for Doubtful Accts 1,700
• (to adjust allowance to total est uncollect)

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So

• Steps for _______________________
• Prepare aging schedule
• Calculate the required Allowance (hint drawing
  a T-account may help here)
• book the Bad Debt Exp

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NOTES RECEIVABLE

• Promissory note
• written promise to pay a specified amount of
  money on demand or at a definite time
• Maker
• The party making the promise.
• Payee
• The party to whom
  payment is made.

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NOTES RECEIVABLE

• Notes receivable give the holder a stronger legal
  claim than accounts receivable
• Can be readily sold to another party
• Three basic accounting issues
• Recognizing notes receivable
• Valuing notes receivable
• Disposing of notes receivable

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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.
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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

• 1. Notes may be held to their maturity (honored)
• Face amount plus interest is received
• 2. Notes may be sold
• To speed up the collection of cash
• 3. Maker of the note may default
• (not pay as agreed)

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HONOR OF NOTES RECEIVABLE
New example

• 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.
• Betty Co. lends Wayne Higley Inc. 10,000 on
  June 1, accepting a 4-month, 9
  interest-bearing note.
• Betty collects the maturity value of the note
  from Higley on October 1.

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HONOR OF NOTES RECEIVABLE
If Betty Co. prepares prepares financial
statements as of September 30, interest for 4
months, or 300, would be accrued.
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HONOR OF NOTES RECEIVABLE
Continuation of last slide
When interest has been accrued, it is necessary
to credit Interest Receivable at maturity Why
DONT we book any interest rev?
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DISHONOR OF NOTES RECEIVABLE
New situation!!! Dishonored

• 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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BS ISand RECEIVABLES

• In the balance sheet, short-term receivables are
  reported in the current assets section below
  short-term investments.
• Report both the gross amount of receivables and
  the allowance for doubtful accounts.
• The income statement will show
• Bad debts expense
• Interest revenue

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MANAGING RECEIVABLES
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EVALUTING LIQUIDITY OF RECEIVABLES

• Ratios are computed to evaluate the liquidity
  (how quickly the asset can be converted to cash)
  of a companys accounts receivable.
• Accounts receivables turnover ratio 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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EVALUTING LIQUIDITY OF RECEIVABLES
Make sure you unpack the formulas!!! What does
NET cred sales mean? Net Rec? Average Net Rec?
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ACCELERATING CASH RECEIPTS

• Cos 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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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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CREDIT CARDS ADVANTAGES TO THE RETAILER
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VISA, MASTERCARD, DISCOVER SALES
Anita Ferreri purchases a number of compact discs
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.
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SALE OF RECEIVABLES
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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Lets Review
Brendan Corporation sells its goods on terms of
2/10, n/30. It has a receivables turnover ratio
of 7. What is its average collection period
(days)?
a. 2,555.
b. 30.
c. 52.
d. 210.
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Lets Review
Brendan Corporation sells its goods on terms of
2/10, n/30. It has a receivables turnover ratio
of 7. What is its average collection period
(days)?
a. 2,555.
b. 30.
c. 52.
d. 210.