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Financial Accounting:Tools for Business Decision Making, 2nd Ed.
Kimmel, Weygandt, Kieso
ELS
Chapter 8
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Chapter 8Reporting and Analyzing ReceivablesAfter 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 ReceivablesAfter 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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Represent claims for which formal instruments of credit are issued as evidence of debt.
Notes Receivable...
Illustration 8-9
2001
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Other Receivables
Nontrade including: interest receivableloans to company officersadvances to employeesincome 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
Bad debt expense will show only actual losses.
Accounts receivable will be reported at gross amount.
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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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Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000
Accounts ReceivableAllowance for
Doubtful Accounts
Jan 1 Bal 200,000 Jan 1 Bal 12,000
Recording Estimated Uncollectibles
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Is the net amount expected to be collected in cash.
Excludes amounts the company estimates it will not collect.
Cash (Net) Realizable Value...
Keeps Receivables from Being Overstatedon the Balance Sheet.
HAMPTON FURNITUREBalance Sheet (partial)
Current assets Cash $ 14,800
Accounts receivable $200,000Less: Allowance for doubtful accounts 12,000 188,000
Cash (net) Realizable Value
Illustration 8-4
HAMPTON FURNITUREBalance Sheet (partial)
Current assets Cash $ 14,800
Accounts receivable $200,000Less: Allowance for doubtful accounts 12,000
188,000Merchandise Inventory 310,000
Prepaid Expense 25,000Total current assets $537,800
Illustration 8-4
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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
Write-off of an Uncollectible Account
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Write-off of an Uncollectible Account
Allowance for Doubtful Accounts 500
Accounts Receivable-Ware 500
Accounts ReceivableAllowance for
Doubtful Accounts
Jan 1 Bal 200,000 Mar 1 500
Mar 1 Bal 199,500
Jan 1 Bal 12,000Mar 1 500
Mar 1 Bal 11,500
Illustration 8-5
Current assets Cash $ 14,800
Accounts receivable $200,000Less: Allowance for doubtful accounts 12,000 188,000
Current assets Cash $ 14,800
Accounts receivable $199,500Less: Allowance for doubtful accounts 11,500 188,000
Before Write-off
After Write-off
Cash Realizable Value
Cash Realizable Value
Illustration 8-6
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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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Notes and accounts receivables that result from sales transactions.
Trade Receivables...
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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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Credit instrument normally requires:payment of interest extends for time periods of 60-90
days or longer.
Notes Receivable...
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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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Represent claims for which formal instruments of credit are issued as evidence of debt.
Notes Receivable...
Illustration 8-9
2001
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Maturity Date
Term of note 60 days
July (31-17) 14
August 31 45
Maturity date, September 15
The maturity date of a 60-day note dated July 17 is computed as follows:
Illustration 8-10
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Maker
Is the party in a promissory note who is making the promise to pay.
Payee
Is the party to whom payment of a promissory note is to be made.
Payee
Is the party to whom payment of a promissory note is to be made.
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 ReceivablesDetermine 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 PeriodDetermine 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 company’s 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...
Is a measure of the risk that a company’s 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 company’s overall credit risk is increasing and decreasing.
Illustration 8-14
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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=
Net Credit SalesAverage Net Receivables
Is a measure of the liquidity of receivables.
Illustration 8-17
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Average Collection Period=
365 daysReceivables Turnover Ratio
Is the average amount of time that a receivable is outstanding
Illustration 8-17
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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 ReceivablesThey 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 CardAmerican
Express.
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Credit Card
Three parties are involved when national credit cards are used in making retail sales:
the credit card issuerthe retailerthe 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.
Advantages of Credit Cards to the Retailer
Illustration 8-18
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Advantages of Credit Cards to the Retailer
Illustration 8-18
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Advantages of Credit Cards to the Retailer
Illustration 8-18
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Advantages of Credit Cards to the Retailer
Illustration 8-18
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