Financial Accounting: Tools for Business Decision Making, 2nd Ed'

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Financial AccountingTools for Business Decision
Making, 2nd Ed.
Kimmel, Weygandt, Kieso
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
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Chapter 8
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Chapter 8Reporting and Analyzing Receivables

• After studying Chapter 8, 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 maturity date of and interest on
  notes receivable.
• Describe the entries to record the disposition of
  notes receivable.

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Chapter 8Reporting and Analyzing Receivables

• After studying Chapter 8, you should be able to
  
• Explain the statement presentation of
  receivables.
• Describe the principles of sound accounts
  receivable management.
• Identify ratios to analyze a company's
  receivables.
• Describe methods to accelerate the receipt of
  cash from receivables.

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Receivables...

• Amounts due from individuals and companies-
  expected to be collected in cash.
• Frequently classified as
• Accounts receivable
• Notes receivable
• Other receivables

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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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Illustration 8-9
Notes Receivable...

• Represent claims for which formal instruments
  of credit are issued as evidence of debt.

2001
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Other Receivables

• Nontrade including
• interest receivable
• loans to company officers
• advances to employees
• income taxes refundable

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Accounts Receivable...

• Are recorded when service is provided or at
  point of sale of merchandise on account.
• Accounts Receivable 100
• Sales 100

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Bad Debts Expense...

• Is an expense to record estimated
  uncollectible receivables.

Keeps Expenses from Being Understated on the
Income Statement.
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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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Allowance Method

• Uncollectible accounts receivable are estimated
  and matched against sales in the same accounting
  period in which the sales occurred.
• Uncollectible accounts receivable may be
  estimated using
• Percentage of sales
• Aging of accounts receivable

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Recording Estimated Uncollectibles

• Hampton Furniture has credit sales of
  1,200,000, of which 200,000 remains
  uncollected. The credit manager estimates
  12,000 will prove uncollectible.
• Bad Debts Expense 12,000
• Allowance for Doubtful
• Accounts 12,000

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Recording Estimated Uncollectibles

• Bad Debts Expense 12,000
• Allowance for Doubtful
• Accounts 12,000

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Cash (Net) Realizable Value...

• Is the net amount expected to be collected in
  cash.
• Excludes amounts the company estimates it will
  not collect.

Keeps Receivables from Being Overstated on the
Balance Sheet.
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HAMPTON FURNITURE Balance Sheet (partial)
Illustration 8-4

• Current assets
• Cash 14,800
• Accounts receivable 200,000
• Less Allowance for doubtful accounts
  12,000 188,000

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HAMPTON FURNITURE Balance Sheet (partial)
Illustration 8-4

• Current assets
• Cash 14,800
• Accounts receivable 200,000
• Less Allowance for doubtful accounts
  12,000 188,000
• Merchandise Inventory 310,000
• Prepaid Expense 25,000
• Total current assets 537,800

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Write-off of an Uncollectible Account

• The vice president of finance authorizes a
  write-off of 500 owed by R.A.Ware.
• Allowance for Doubtful
• Accounts 500
• Accounts Receivable-Ware 500

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Write-off of an Uncollectible Account
Illustration 8-5

• Allowance for Doubtful
• Accounts 500
• Accounts Receivable-Ware 500

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Before Write-off
Illustration 8-6

• Current assets
• Cash 14,800
• Accounts receivable 200,000
• Less Allowance for doubtful accounts
  12,000 188,000

After Write-off
Current assets Cash 14,800 Accounts
receivable 199,500 Less Allowance for doubtful
accounts 11,500 188,000
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Recovery of an Uncollectible Account

• Accounts Receivable-Ware 500
  Allowance
  for Doubtful
• Accounts
  500
• Cash 500
• Accounts Receivable 500

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Percentage of Receivables...

• Management establishes a percentage
  relationship between the amount of receivables
  and the expected losses from uncollectible
  accounts.

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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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Trade Receivables...

• Notes and accounts receivables that result
  from sales transactions.

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Notes Receivable...

• Result from sale of goods and services.
• Often called trade receivable.
• Give holder a stronger legal claim to assets than
  accounts receivable.
• Are negotiable instruments and may be transferred
  to another party by endorsement.

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Notes Receivable...

• Credit instrument normally requires
• payment of interest
• extends for time periods of 60-90 days or longer.

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Notes Receivable...

• Are often accepted from customers who need to
  extend payment of an account receivable.
• Are often required
  from high-risk
  customers.

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Notes Receivable

• The life of a note may be expressed in months or
  days.
• When the life of a note is expressed in terms of
  months, the due date is found by counting the
  months from the date of issue.

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Notes Receivable

• When the due date is stated in terms of days,
  count the exact number of days to determine the
  maturity date.
• In counting, the date the note is issued is
  omitted but the due date is included.

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Illustration 8-9
Notes Receivable...

• Represent claims for which formal instruments
  of credit are issued as evidence of debt.

2001
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Maturity Date
Illustration 8-10
The maturity date of a 60-day note dated July 17
is computed as follows

• Term of note 60 days
• July (31-17) 14
• August 31 45
• Maturity date, September 15

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Maker
Is the party in a promissory note who is making
the promise to pay.
Payee
Payee
Is the party to whom payment of a promissory note
is to be made.
Is the party to whom payment of a promissory note
is to be made.
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Formula for Interest
Illustration 8-11
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Notes Receivable...

• are recorded at face value.
• are reported at cash (net) realizable value.
• are honored when paid in full at maturity.
• are dishonored when not paid in full at
  maturity.

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Notes Receivable...

• Interest revenue is recorded when the note is
  paid.
• If interim financial statements are prepared,
  interest on notes receivable is accrued.

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Notes Receivable...

• Each type of receivables should be identified in
  the balance sheet or in the notes to the
  financial statements.
• Short-term receivables are reported in the
  current asset section of the balance sheet below
  short-term investments.
• The gross amount of receivables and the allowance
  for doubtful accounts should be reported.

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Notes Receivable...

• Notes receivable are listed before accounts
  receivable because notes are more easily
  converted to cash.
• Bad debts expense is reported as a selling
  expense in the income statement.
• Interest revenue is shown under Other Revenues
  and Gains in the nonoperating section of the
  income statement.

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Managing Receivables

• Determine to whom to extend credit.
• Establish a payment period.
• Monitor collections.
• Evaluate receivables balance.
• Accelerate cash
  receipts from
  receivables when necessary.
  

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Extending Credit

• Risky customers might be required to provide
  letters of credit or bank guarantees.
• Risky customers might be required to pay cash on
  delivery (COD).
• Ask potential customers for references from banks
  and suppliers and check the references.
• Periodically check financial health of continuing
  customers.

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Payment Period

• Determine a required payment period and
  communicate that policy to customers.
• Make sure company's payment period
  is consistent with that
  of competitors.

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Monitoring Collections

• Calculate companys credit risk ratio.
• Prepare accounts receivable aging schedule at
  least monthly.
• Pursue problem accounts
  with
• phone calls
• letters
• legal action if
  necessary.

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Credit Risk Ratio...
Illustration 8-14

• Is a measure of the risk that a companys
  customers may not pay their accounts.

Credit Risk Ratio Allowance for Doubtful
Accounts Accounts Receivables
Changes in credit risk ratio over time
suggests that a companys overall credit risk is
increasing and decreasing.
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Concentration of Credit Risk

• Is a threat of nonpayment from a single
  customer or class of customers that could
  adversely affect the financial health of the
  company.

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Evaluating the Receivables Balance

• Liquidity is measured by how quickly certain
  assets can be converted into cash.
• The receivables turnover ratio measures the
  number of times, on average, receivables are
  collected during
  the period.

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Receivables Turnover Ratio
Illustration 8-17

• Net Credit Sales
• Average Net Receivables

Is a measure of the liquidity of receivables.
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Average Collection Period
Illustration 8-17

• 365 days
• Receivables Turnover Ratio

Is the average amount of time that a receivable
is outstanding
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Accelerating Cash Receipts
Waiting for the normal collection process cost
money.
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Accelerating Cash Receipts
A bird in the hand is worth two in the bush.
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Companies Sell Receivables

• They get more sales if they provide financing to
  customers.
• General Motors Acceptance Corporation
• Ford Motor Credit Corporation
• They may be the only reasonable
  source of cash.
• Billing and collection are often
  time-consuming and
  costly.

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Factor...

• Is a finance company or bank that buys
  receivables from businesses for a fee and then
  collects payments
  directly
  from the
  customers.

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Expense Associated with Selling Receivables

• If a company usually sells its receivables, the
  service charge expense is recorded as a selling
  expense.
• However, if receivables are sold infrequently the
  fee may be reported under Other Expenses and
  Losses in the income statement.

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Credit Card

• A common type of credit card is a national
  credit card such as
• Visa
• Master Card
• American Express.

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Credit Card

• Three parties are involved when national credit
  cards are used in making retail sales
• the credit card issuer
• the retailer
• the customer

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Bank Credit Card

• Sales resulting from the use of VISA and
  MasterCard are considered cash sales by the
  retailer.
• Upon receipt of credit card sales slips from a
  retailer, the bank immediately adds the amount to
  the seller's bank balance.

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Advantages of Credit Cards to the Retailer
Illustration 8-18
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Illustration 8-18
Advantages of Credit Cards to the Retailer
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Illustration 8-18
Advantages of Credit Cards to the Retailer
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Illustration 8-18
Advantages of Credit Cards to the Retailer
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