7-1 Receivables Chapter 7 Electronic Presentation by Douglas Cloud Pepperdine University

ReceivablesChapter 7

Electronic Presentation by Douglas Cloud

Pepperdine University

1. Describe the common classifications of receivables.

2. Summarize and provide examples of internal control procedures that apply to receivables.

3. Describe the nature of and the accounting for uncollectible receivables.

4. Describe the allowance method of accounting for uncollectible receivables.

Learning GoalsLearning Goals

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinued

5. Describe the direct write-off method of accounting for uncollectible receivables.

6. Describe the nature, characteristics, and accounting for notes receivable.7. Describe the reporting of receivables on the balance sheet.8. Describe the principles of managing receivables.

ContinuedContinued

9. Compute and interpret the accounts receivable turnover and the number of days’ sales in receivables.

1Learning GoalLearning Goal

Describe the common classifications of receivables.

When merchandise or services are sold on credit, an accounts

receivable is established.

Most accounts receivable are expected to be collected in 30 to

60 days; so, they are current assets.

Dec. 13, 2005

I promise to pay__________________________________

____________________________________________

at an interest rate of _____% within ______ days.

________________________

Douglas CloudOne Thousand Dollars and no/100 6 90 T. Wood

Notes receivable are amounts that customers owe for which a formal, written instrument of

credit has been issued.

Notes and accounts receivable that result from sales

transactions are sometimes called trade receivables.

Summarize and provide examples of internal control procedures that apply to receivables.2

Learning GoalLearning Goal

Describe the nature of and the accounting for uncollectible receivables.

Often when a company issues its own credit card, it sells its

receivables to other companies. This is called factoring and the

buyer is called the factor.

Regardless of the care used in

granting credit and the collection

procedure used, normally a part of

the credit sales will not be collectible.

The two methods of accounting for receivables that appear to be

uncollectible are the allowance method and the direct-write-off method.

Describe the allowance method of accounting for uncollectible receivables.

Richards Company, a new company with a fiscal period ending on December 31,

ends the year with $1,000,000 in the Accounts Receivable account.

Based on careful study, Richards estimates that $40,000 of the $1,000,000

will eventually be uncollectible.

A year-end adjusting entry is needed:

Dec. 31 Uncollectible Accounts Expense 40,000Allowance for Doubtful Accounts 40,000

Also called Also called Bad Bad Debts ExpenseDebts Expense or or

Doubtful Accounts Doubtful Accounts ExpenseExpenseA A contra accountcontra account

to to Accounts Accounts ReceivableReceivable

Because specific customer accounts cannot be identified at this time, the

allowance account is used.

Subtracting the balance of the allowance account from the

receivables balance provides the net realizable value—which is the

amount Richards expects to collect.

$1,000,000 - 40,000$ 960,000

Write-Offs to the Write-Offs to the Allowance AccountAllowance Account

On January 21 John Parker, one of Richards Company’s receivables, files for bankruptcy.

Thus, his account of $6,000 is deemed uncollectible. The following entry is required:

Jan. 21 Allowance for Doubtful Accounts 6,000Accounts Receivable—J. Parker 6,000

Collecting a Written-Off AccountCollecting a Written-Off Account

John Parker won the state lottery, so he is paying all of his bankruptcy debts. On June 10,

Richards Co. receive a check for $6,000.

10 Cash 6,000Accounts Receivable—J. Parker 6,000

June 10 Accounts Receivable—J. Parker 6,000Allowance for Doubtful Accts. 6,000

Estimating UncollectiblesEstimating Uncollectibles

Estimate Based on Sales

Allowance for Doubtful Accounts

Bal. 7,000It is estimated that It is estimated that

1% of the $3 1% of the $3 million in credit million in credit

sales will become sales will become uncollectible.uncollectible.

30,00037,000

The process of determining how long a receivable has been outstanding and

attaching a percentage to that time period is referred to as aging the receivables.

Estimate Based on Analysis of Receivables

Estimating UncollectiblesEstimating UncollectiblesEstimate Based on Analysis of Receivables

The longer an account has been outstanding, the less like the receivable will be collected.

Accounts Receivable Aging and UncollectiblesAccounts Receivable Aging and Uncollectibles

Not Days Past DuePast over

Customer Balance Due 1-30 31-60 61-90 91-180 181-365 365

Ashby & Co. $ 150 $ 150B. T. Barr 610 $ 350 $260Brock Co. 470 $ 470

J. Zimmer Co. 160 160

Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300

Total accounts receivable shown by age.

2%2% 5%5% 10%10% 20%20% 30%30% 50%50% 80% 80%Uncollectibles

PERCENT

Uncollectible percentages based on experience and industry averages.

Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300

2%2% 5%5% 10%10% 20%20% 30%30% 50%50% 80% 80%Uncollectibles

PERCENT

AMOUNT $3,390 =$3,390 = $1,500$1,500 $200$200 $310$310 $380$380 $360$360 $400$400 $240 $240

Total $86,300 $75,000 $4,000 $3,100 $1,900 $1,200 $800 $300

Estimate Based on Analysis of Receivables

Allowance for Doubtful Accounts

Bal. 510

By aging, it is estimated that

$3,390 of the credit sales will become

uncollectible.

2,8803,390

Estimating UncollectiblesEstimating UncollectiblesEstimate Based on Analysis of Receivables

Notice that when the estimation is based on accounts receivable, the calculated

amount is the desired ending balance in the allowance account.

Describe the direct write-off method of accounting for uncollectible receivables.

While the allowance method is preferred, there are

situations where the cash basis is acceptable.

What type of situations?

The direct write-off method is acceptable

when it is impossible to accurately estimate the

uncollectibles.

It is also acceptable when a business sells most of its goods or services for cash. The amount of

uncollectibles is small.

D. L. Ross owes Hankin Company $4,200. All efforts to collect have failed, so on May 10 Hankin decides the account is uncollectible.

May 10 Uncollectible Accounts Expense 4,200Accounts Receivable—D. L. Ross 4,200

Note that the direct write-off-method Note that the direct write-off-method debits the expense account at the debits the expense account at the

time of the write-off.time of the write-off.

On November 21, Hankin receives a check for $4,200 from D. L. Ross.

Nov. 21 Accounts Receivable—D. L. Ross 4,200Uncollectible Accounts Expense 4,200

This entry “reinstates” the debt.

21 Cash 4,200Accounts Receivable—D. L. Ross 4,200

Describe the nature, characteristics, and accounting for notes receivable.6

Notes ReceivableNotes Receivable

$_____________Fresno, California______________20___March 16 05

________________ _AFTER DATE _______ PROMISE TO PAY TO Ninety days WeTHE ORDER OF ____________________________________________ Judson Company

_________________________________________________DOLLARSTwo thousand five hundred 00/100---------------------------PAYABLE AT ______________________________________________

City National Bank

VALUE RECEIVED WITH INTEREST AT ____10%

2,500.00

NO. _______ DUE___________________14 June 14, 2005

TREASURER, WILLIARD COMPANYH. B. Lane

PayeePayee

MakerMakerDue DateDue Date

a specific amount of money (principal)a specific amount of money (principal) to a specific person or company (payee)to a specific person or company (payee) by a specific person (maker) by a specific person (maker) on a specific date or upon demandon a specific date or upon demand plus interest at a specific percentage of the plus interest at a specific percentage of the

principal (face) amount per yearprincipal (face) amount per year

A promissory note is a written document containing a promise to pay:

Principal + Interest = Maturity Value $6,000 + $60 = $6,060

Principal x Rate x Time = Interest

$6,000 x 12% x 30/360 = $60

Interest CalculationInterest Calculation

Received a $6,000, 12%, 30-day note dated November 21, 2005 from W. A. Bunn in

settlement of a past-due account.

Maturity Value CalculationMaturity Value Calculation

Nov. 21 Notes Receivable—W. A. Bunn 6,000Accounts Receivable—W. A. Bunn 6,000

When the note is received.When the note is received.

Dec. 21 Cash 6,060Notes Receivable—W. A. Bunn 6,000Interest Revenue 60

At maturity date.At maturity date.

If a note matures in a later fiscal period, the company holding the note makes an adjusting entry for accrued

interest.

Dec. 13, 2005

I promise to pay__________________________________

____________________________________________

at an interest rate of _____% within ______ days.

________________________

Douglas CloudOne Thousand Dollars and no/100 6 90 T. Wood

Crawford Company uses a 90-day, 12% note, dated December 1, 2005, to settle its account, which has a balance of $4,000.

Dec. 31 Interest Receivable 40Interest Revenue 40

Dec. 1 Notes Receivable—Crawford Co. 4,000Accounts Receivable— Crawford Co. 4,000

$4,000 x .12 x 30/360

Mar. 1 Cash 4,120Notes Receivable 4,000Interest Receivable 40Interest Revenue 80

Describe the reporting of receivables on the balance sheet.7

Starbucks’ASSETS Sept. 30, 2001 (in thousands)Current assets:

Cash and cash equivalents $113,237Marketable securities 107,312Accounts receivable, net of allowance of $4,590 90,425Inventories 221,253Prepaid expenses and other current assets 61,698

Total current assets $593,925

Describe the principles of managing accounts receivable.8

Screening CustomersScreening Customers

Screening customers involves assessing

which customers should be granted credit.

In addition to analyzing the buyer’s application

and documents, the seller usually requires an independent credit

report…

…and often will contact the buyer’s bank and

other credit references. Dun & Bradstreet

provides credit ratings for many business

customers.

Determining Credit TermsDetermining Credit TermsOnce a seller has decided to grant credit to a buyer, the

seller must determine credit terms for the sale.

Determining Credit TermsDetermining Credit TermsThis includes determining a credit limit which is based on the credit worthiness of

the customer.

Monitoring CollectionsMonitoring Collections

Sellers should monitor

concentrations of credit risk in any one customer or class of

customers.

Compute and interpret the accounts receivable turnover and the number of days’ sales in receivables.

Accounts Receivable TurnoverAccounts Receivable Turnover 2006 2005

Net sales on account $1,498,000 $1,200,000Accounts receivable (net):

Beginning of year $ 120,000 $ 140,000End of year 115,500 120,000Total $ 235,000 $ 260,000Average $ 117,500 $ 130,000

$1,498,000$117,500

$1,200,000$130,000

Net SalesAverage accounts receivable

Use: To assess the efficiency in collecting receivables and in the management of credit

12.7 9.2

Number of Days’ Sales in ReceivablesNumber of Days’ Sales in Receivables 2006

Net sales on account $1,498,000Accounts receivable (net):

Beginning of year $ 120,000End of year 115,500Total $ 235,000Average $ 117,500

Accounts receivable, end of yearAverage daily sales on account

$115,500($1,498,000 ÷ 365 days)

= 28 days

Use: To assess the efficiency in collecting receivables and in the management of credit

The End

Chapter 7Chapter 7

7-1 Receivables Chapter 7 Electronic Presentation by Douglas Cloud Pepperdine University

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