Receivables

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 8

1

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.2

Define and explain common types of receivables and review internal controls for receivables

Use the allowance method to account foruncollectibles

Understand the direct write-off method foruncollectibles

Journalize credit-card and debit-card sales


Account for notes receivable

Report receivables on the balance sheet and evaluate a company using the acid-test ratio, days’ sales in receivables, and the accounts receivable turnover ratio

Discount a note receivable (see Appendix 8A)


Define and explain common types of receivables and review internal controls for receivables

4

11


Selling goods or services to another party on creditRight to receive cash in the future from a current transactionTwo types:

Accounts receivableNotes receivable

An asset

5


Amounts to be collected from customers for sales on creditServes as a control account

Control account –account that summarizes related subsidiary accounts.

Customer ledgerSubsidiary ledger showing each customer’s balance

6


More formal than accounts receivableUsually longer in term

Debtor promises to pay by maturity dateMaturity date–date the debt must be completely paid off

Current assets if due within one year or lessLong-term assets if due beyond one yearPromissory note

Written document signed by both parties

7


Credit department evaluates customers’ applicationsSeparation of duties

Credit department should not handle cashCash handlers should not extend credit

8


What is the difference between accounts receivable and notes receivable?

9

Notes receivable include a charge for interest; accounts receivable do not.

Accounts receivable are current assets; notes receivable are current or long-term assets.

Notes receivable are more formal than accounts receivable.

Notes receivable are evidenced by the debtor signing a promissory note; accounts receivable are not.


Use the allowance method to account for uncollectibles

10

22


Selling on credit:BENEFIT–Increase sales by selling to a wider range of customersCOST–Some customers don’t pay

Results in uncollectible account expense

Two methods to account for uncollectible accounts:

Allowance methodDirect write-off method

11


Starts with selling on account

Collecting cash is the second step

12


Based on the matching principleRecord uncollectible accounts expense in same period as salesExpense is estimated from past experience

Offset to expense is the allowance for uncollectible accounts

A contra asset, contra to accounts receivableReduces account receivables to a net receivable

13


Companies use their history, the economy and industry information to estimate uncollectiblesPercent-of-sales

Income-statement approachEstimates uncollectible accounts as a percent of sales

Aging-of-accountsBalance-sheet approachDetermine target allowance based on age of actual receivables

14


Begins with account balancesBeginning balance below

Compute the estimate and journalize it

Net realizable value is the expected amount to collect

15


During its first year of operations, Spring Garden Plans earned revenue of $322,000 on account. Industry experience suggests that bad debts will amount to 2% of revenues.

At December 31, 2012, accounts receivable total $36,000. The company uses the allowance method to account for uncollectibles.

16


Journal EntryDATE ACCOUNTS AND EXPLANATIONS DEBIT CREDIT

Dec 31 Accounts receivable 322,000

Sales revenue 322,000

31 Uncollectible account expense (322,000 x .02) 6,440

Allowance for uncollectible accounts 6,440

1. Journalize Spring’s sales and uncollectible account expense using the percent-of sales method.

17


2. Show how to report accounts receivable on the balance sheet at December 31, 2012. Use the long reporting format illustrated in the chapter.

18

Balance sheet (Partial):

Accounts receivable $36,000

Less: Allowance for uncollectible accounts $ 6,440

Accounts receivable, net $29,560


Focuses on actual age of the accounts receivableDetermines a target allowance balance

19

ARTotal

Expected not to collect


The amount not expected to be collected becomes the allowance account target balance

Journal entry$150 credit balance plus/minus adjustment = $400

20


Summer and Sandcastles Resort had the following balances at December 31, 2012, before the year-end adjustments:

The aging of accounts receivable yields the following data:

21

Accounts receivable Allowance for uncollectible accounts 78,000 Beg Bal 1,900

Age of Accounts Receivable

0-60 days Over 60 Days Total Receivables

Amount receivable $75,000 $3,000 $78,000

% uncollectible × 4% × 24%

Amount uncollectible $3,000 + $720 = $ 3,720


1. Journalize Summer’s entry to adjust the allowance account to its correct balance at December 31, 2012.

2. Prepare a T-account to compute the ending balance of Allowance for uncollectible accounts.

22

Accounts receivable Allowance for uncollectible accounts 78,000 Beg Bal 1,900

Adj 1,820 _ __________________________________________

End Bal 3,720

Journal EntryDATE ACCOUNTS AND EXPLANATIONS DEBIT CREDIT2012

Dec 31 Uncollectible account expense ($3,720 − $1,900) 1,820Allowance for uncollectible accounts 1,820


When a specific customer account is identified as uncollectible, it is written off to the allowance account

23


Sometimes a customer will pay the amount owed after the customer’s account is written offTwo entries needed:

Reverse the uncollectable accountRecord the payment

24


Make sales on accountEstablish a pool for future potential uncollectibility (2%)Collect cash on accountIdentify a bad debtAdjust allowance account to reflect adjustments to the estimateRecover previously written off account

25



Understand the direct write-off method foruncollectibles

27

33


Used by small businessesNo Allowance for uncollectible accountsRecords uncollectible accounts expense when specific account is written off


Overstates Accounts receivable on the balance sheet

No Allowance account

Violates matching principleUncollectible account expense often not in same period as sale

29


Direct write-off of debt recovery process is different from the allowance methodThe debt was written off the booksTo recover:

Reverse the write-off journal entryRecord the cash payment

30


Gate City Cycles had trouble collecting its account receivable from Sue Ann Noel. On June 19, 2012, Gate City finally wrote off Noel’s $700 account receivable. Gate City turned the account over to an attorney, who hounded Noel for the rest of the year. On December 31, Noel sent a $700 check to Gate City Cycles with a note that said, “Here’s your money. Please call off your bloodhound!”

1. Journalize the entries required for Gate City Cycles, assuming Gate City uses the direct write-off method.

31


Journal Entry

DATE ACCOUNTS AND EXPLANATIONS DEBIT CREDIT

Jun 19 Uncollectable account expense 700

Accounts receivable—Sue Ann Noel 700

Dec 31 Accounts receivable—Sue Ann Noel 700

Uncollectable account expense 700

Dec 31 Cash 700

Accounts receivable—Sue Ann Noel 700

Collected on account.


Journalize credit-card and debit-card sales

33

44


Credit-card sales are an alternative form for receiving paymentsTwo types:

Issued by a financial institutionVisaMastercard

Issued by a credit card companyAmerican ExpressDiscover

34


Different than credit and bankcardsSame as cash

Amount subtracted from buyer’s bank accountAmount added to retailer’s bank account

35


Retailers receive cash at time of saleVisa and MasterCard most common bank cardsRetailer accepting the credit cards pays a feeTwo types of fee transactions:

NET: The total sale less the processing fee assessed equals the net amount of cash depositedGross: The total sale is deposited and the fee is deducted at the end of the month

Journal entry similar to cash sales

36


Restaurants do a large volume of business by credit and debit cards. Suppose Chocolate Passion restaurant had these transactions on January 28, 2012:

National Express credit-card sales . . . . . $ 9,300ValueCard debit-card sales . . . . . . . . . . . 9,000

Suppose Chocolate Passion’s processor charges a 3% fee and deposits sales net of the fee.

Requirement:1. Journalize these sale transactions for the restaurant.

37


Journal Entry

DATE ACCOUNTS AND EXPLANATIONSPOST.REF. DEBIT CREDIT

Jan 28 Cash $9,021Card discount expense ($9,300 × .03) 279

Sales revenue $9,300Recorded credit-card sales, net of fee.

28 Cash 8,730Card discount expense ($9,000 × .03) 270

Sales revenue 9,000Recorded bank card sales, net of fee.

National Express credit-card sales . . . . . $ 9,300ValueCard debit-card sales . . . . . . . . . . . 9,000


Account for notes receivable

39

55


More formal than Accounts receivableDebtor signs promissory note

A written promise to pay a specified amount of money at a particular future date

40



Maturity date can be:A specific date, such as March 13Stated in terms of number of months

A six-month note dated February 16, 2014, would mature on August 16, 2014

Stated in terms of number of daysMust count days from issue date to maturity day

42


A 180-day note dated February 16, 2014 matures on August 15, 2014

43


By the year

By the month

By the day

44


If notes receivable are outstanding, interest must be accruedInterest is earned over timeRevenue must be recorded in the period earned

45


On the maturity date

46




A company may accept a note receivable from a customer who fails to pay an account receivable

49


Lakeland Bank & Trust Company lent $110,000 to Samantha Michael on a 90-day, 9% note.

1. Journalize the following transactions for the bank (explanations are not required):

a. Lending the money on June 6.b. Collecting the principal and interest at maturity.

Specify the date. For the computation of interest, use a 360-day year.

50


Journal Entry

DATE ACCOUNTS AND EXPLANATIONSPOST.REF.

DEBIT CREDIT

Jun 6 Note receivable—Samantha Michael 110,000Cash 110,000

Sept 6 Cash 112,475

Note receivable—S. Michael 110,000

Interest revenue 2,475

($110,000 × .09 × 90/360)

a. Lending the money on June 6.b. Collecting the principal and interest at maturity.

Specify the date. For the computation of interest, use a 360-day year.


Maker of note does not payMove the note receivable into accounts receivableInterest is added to the new accounts receivable

52


Accounts receivable can be computerized allowing the order entry, shipping, and billing departments to work together

53


Report receivables on the balance sheet andevaluate a company using the acid-test ratio,days’ sales in receivables, and the accounts

receivable turnover ratio

54

66


Current asset, shown net of allowances Two presentation styles:

55


Also called the “quick ratio”Stringent measure of liquidityMeasures entity’s ability to pay its current liabilities immediately

56


Also called “collection period”It is number of days it takes to collect the average balance of receivablesThe shorter the collection period, the more quickly cash is availableTwo step process:

Find one day’s salesFind day’s sales in receivables

57


Step 1: One day’s sales is calculatedNet sales (Total revenues) divided by 365 days per year

58


Step 2: Day’s sales in inventoryAverage net receivables divided by one days sales

59


Measures the number of times the company sells and collects the average receivables Higher the ratio, the faster the cash collections occurBenchmark on how well a company is managing its receivables

60


Northend Medical Center included the following items in its financial statements:

1.How much net income did Northend earn for the month?

61

Service revenue............................................………… $14,700

Less: Cost of services sold and other expenses… 12,400

Net income.........................................………………… $ 2,300


2. Show two ways Northend can report receivables on its classified balance sheet:

62

Current assets:

Accounts receivable.............................…………... $2,590

Less: Allowance for doubtful accounts............. ___150

Accounts receivable, net................................…... $ 2,440

or

Accounts receivable, net of allowance

for uncollectible accounts of $150…………... $2,440


Southside Clothiers reported the following items at September 30, 2012 (last year’s—2011—amounts also given as needed):

Compute Southside’s (a) acid-test ratio, (b) days’ sales in average receivables for 2012, and (c) accounts receivable turnover ratio. Evaluate each ratio value as strong or weak. Southside sells on terms of net 30.

63


= $260,000 + $140,000 + $270,000 $500,000 = $670,000

$500,000 = 1.34

Southside’s position is strong.

64

(a) Acid-test ratio =

Cash + Short-term investments + Net current receivables Total current liabilities


(b) Days’ sales in average receivables =

* Average net accounts receivable ** One day’s sales

*Average net accounts receivable = $170,000+270,000/2 = *$220,000**One day’s sale=(Net sales/365 days) = $2,920,000/365 days = **$8,000

The days’ sales in average receivables are strong relative to credit terms of net 30.65

= 28 days *$220,000 **$8,000


66

(c)Accounts receivable

Turnover Ratio =

Net sales revenueAverage net accounts

receivable

=$2,920,000$220,000

= 13.3

Southside’s accounts receivable turnover ratio is strong relative to credit terms of net 30.


Discount a note receivable (see Appendix 8A)

67

77


The payee needs cash before the maturity datePayee sells the receivablesAmount is determined by present-value concepts

68


Compute the original amount of interest on the note receivableMaturity value of the note = Principal + InterestDetermine the period (number of days, months, or years) the bank will hold the note (the discount period)Compute the bank’s discount on the note

This is the bank’s interest revenue from holding the note

Seller’s proceeds from discounting the note receivable = Maturity value of the note – Bank’s discount on the note

69


$1,000 note is received on September 30, 2015Maturity date is one yearNote is discounted on November 30, 2014Interest applied is 12%, and is higher than notesAmounts received is called proceeds

70


If proceeds are less than principle amount, the payee debits Interest expense

If proceeds are greater than principle amount, the payee debits Interest revenue

71


The two main differences between accounts receivable and notes receivable are that :1) accounts receivable are usually collected in a short time, such as within 30 days; and 2) notes receivable are usually longer in term and have a signed, interest-bearing document to support the note.The allowance method records Uncollectible account expense based on estimating the future potential that the company won’t collect. This estimate is based on experience, economy, and other factors. So the company knows that–historically–some percentage of customers will not pay.

72


There is no allowance for uncollectible accounts account or estimates used for the direct write-off method. The expense is journalized at the time the company determines a customer cannot pay.Most companies accept debit and/or credit cards as payment for sales. Companies can likely increase sales by offering customers the option to pay with debit/credit cards. This also allows the company to get its cash sooner, but a small fee is paid for that convenience.

73


Notes receivable are another form of receivable that also earn interest. Interest, whether earned or incurred, is calculated as principal x rate x time. The passage of time is what creates the interest.Accounts receivable, net of allowance, is listed in the Current asset section of the balance sheet. Notes receivable is listed as current only if the note will be collected in one year or less. Ratios serve as benchmarks to see how well a company is managing its receivables.

74



Copyright

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

76

Business

Receivables