Chapter 8

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 8

Reporting andInterpreting Receivables,Bad Debt Expense, andInterest Revenue

8-2

Accounts Receivable

Accounts Receivable

Amounts owed by other companies

or persons for cash, goods, or

services.

Open accounts owed to the

business by trade customers.

8-3

Notes Receivable

A note receivable is a written contractestablishing the terms by which a

company will receive amounts it is owed.

Companies may convert accounts

receivable balances to notes for customers

who are having difficulty paying their receivables.

Companies may convert accounts

receivable balances to notes for customers

who are having difficulty paying their receivables.

8-4

$1,200 January 5, 2008

Sixty days after date I promise to pay to

the order of

Skechers U.S.A., Inc.

One thousand two hundred --------------------------------- Dollars

Payable at

First National Bank

Value received with interest at per annumNo. Due

Jones Athletic Company

8563 March 6, 2008

8%

Alan Jones

Notes Receivable

Due Date

Interest Rate

TermPayee

Principal

8-5

Learning Objective 1

Describe the tradeoffs of

extending credit.

8-6

Extending credit is likely to increasesales, but not without costs:

Increased wage costs to manage receivablesIncreased wage costs to manage receivables

Bad debtscosts

Bad debtscosts

Delayed receiptof cash

Delayed receiptof cash

Businesses extend credit togenerate additional sales and to

meet the terms offered by competitors.

Pros and Cons of Extending Credit

8-7


Estimate and report the effects of uncollectible

accounts.

8-8

Accounts Receivableand Bad Debts

Bad debts result from credit customers who will not pay the business the amountthey owe, regardless of collection efforts.

Bad debts result from credit customers who will not pay the business the amountthey owe, regardless of collection efforts.

8-9

Revenues 10,000$ Revenues 0Cost of goods sold 6,000 Cost of goods sold 0Bad debt expense 0 Bad debt expense 1,000 Net income 4,000$ Net income (1,000)$

Year 1(Credit Sale Occurs)

Year 2(Bad Debt discovered)

Bad debts are likely to be discovered inperiods after the credit sale.

If bad debts are not reported until discovered,income is distorted in the periods of sale aswell as in the period of bad debt discovery.

Bad debts are likely to be discovered inperiods after the credit sale.

If bad debts are not reported until discovered,income is distorted in the periods of sale aswell as in the period of bad debt discovery.

Accounts Receivableand Bad Debts

8-10

Bad Debt Expense

Sales Revenue

Record in same accounting period.

Matching Principle

The Allowance Method of Accounting for Bad Debts

8-11

Most businesses record an estimate ofthe bad debt expense with an adjusting

entry at the end of the accounting period.

Most businesses record an estimate ofthe bad debt expense with an adjusting

entry at the end of the accounting period.

The Allowance Method of Accounting for Bad Debts

8-12

Debit CreditAccounts

Record EstimatedBad Debt Expense

For the year ended December 31, 2005, Skechers U.S.A., Inc., estimated itsbad debt expense to be $2,882,000.

Prepare the adjusting entry.

8-13

Debit CreditBad Debt Expense (+E, -SE) 2,882,000

Allowance for Doubtful Accounts (+xA, -A) 2,882,000

Accounts

Bad Debt Expense is normally classified as a selling expense and is closed at year-end.

Contra asset account

Record EstimatedBad Debt Expense

For the year ended December 31, 2005, Skechers U.S.A., Inc., estimated itsbad debt expense to be $2,882,000.

Prepare the adjusting entry.

8-14

Allowance for Doubtful Accounts

Accounts ReceivableLess: Allowance for Doubtful AccountsNet Accounts Receivable

Accounts ReceivableLess: Allowance for Doubtful AccountsNet Accounts Receivable

Amount the businessexpects to collect.

Balance Sheet Disclosure

8-15

Remove (Write Off) Specific Customer Balances

When it is clear that a specific customer’s account receivable will be uncollectible, the

amount should be removed from the Accounts Receivable account and charged

to the Allowance for Doubtful Accounts.

8-16


Skechers’ total write-offs for2005 were $1,729,000.

Prepare a summary journalentry for these write-offs.

Debit CreditAccounts

8-17

Debit CreditAllowance for Doubtful Accounts (-xA) 1,729,000

Accounts Receivable (-A) 1,729,000

Accounts


Skechers’ total write-offs for2005 were $1,729,000.

Prepare a summary journalentry for these write-offs.

8-18

Assume that before the write-off, Skechers’ Accounts Receivable balance was $56,000,000 and the Allowance for

Doubtful Accountsbalance was $6,043,000.

Let’s see what effect the total write-offs of $1,729,000 had on these accounts.

Assume that before the write-off, Skechers’ Accounts Receivable balance was $56,000,000 and the Allowance for

Doubtful Accountsbalance was $6,043,000.

Let’s see what effect the total write-offs of $1,729,000 had on these accounts.


8-19

Before Write-Off

After Write-Off

Accounts Receivable 56,000,000$ 54,271,000$ Less: Allow. for Doubtful Accts. 6,043,000 4,314,000 Net Accounts Receivable 49,957,000$ 49,957,000$

Notice that the total write-offs of $1,729,000 did not change the net accounts receivable value nor did it

affect any income statement accounts.

Notice that the total write-offs of $1,729,000 did not change the net accounts receivable value nor did it

affect any income statement accounts.


8-20

Estimating Bad Debts

Aging of Accounts ReceivableAging of Accounts Receivable

????

Focus is on determining the desired balance in the Allowance for Doubtful

Accounts on the balance sheet.

8-21

Aging Schedule

Each customer’s account is aged by separating the total amount owed by each customer into

aging categories based on the number of days that have passed since uncollected amounts

were first recorded in the account.

Let’s look on the next slide to see an aging of accounts receivable for Skechers (all amounts

in thousands).

Each customer’s account is aged by separating the total amount owed by each customer into

aging categories based on the number of days that have passed since uncollected amounts

were first recorded in the account.

Let’s look on the next slide to see an aging of accounts receivable for Skechers (all amounts

in thousands).

8-22

Number of Days Unpaid

CustomerTotal A/R Balance 0-30 30-60 60-90 Over 90

Adam's Sports 648$ 405$ 198$ 45$ Backyard Shoe 2,345 2,345$

Other Customers 138,803 96,255 18,458 19,605 4,485 Total 141,796$ 96,660$ 18,656$ 19,650$ 6,830$ % UncollectibleEstimatedUncoll. Amount

Next, based on past experience, the business estimates the percentage of uncollectible

accounts in each time category.

(in thousands)

Aging Schedule

8-23




Other Customers 138,803 96,255 18,458 19,605 4,485 Total 141,796$ 96,660$ 18,656$ 19,650$ 6,830$ % Uncollectible 1% 4% 14% 40%EstimatedUncoll. AmountNow we will multiply these percentages

by the appropriate column totals.

(in thousands)

Aging Schedule

8-24




Other Customers 138,803 96,255 18,458 19,605 4,485 Total 141,796$ 96,660$ 18,656$ 19,650$ 6,830$ % Uncollectible 1% 4% 14% 40%EstimatedUncoll. Amount 7,196$ 967$ 746$ 2,751$ 2,732$

The column totals are then added to arrive at the total estimate of

uncollectible accounts of $7,196.

(in thousands)

Aging Schedule

8-25




Other Customers 138,803 96,255 18,458 19,605 4,485 Total 141,796$ 96,660$ 18,656$ 19,650$ 6,830$ % Uncollectible 1% 4% 14% 40%EstimatedUncoll. Amount 7,196$ 967$ 746$ 2,751$ 2,732$

Aging of Accounts Receivable

Record the year-end adjusting entry assuming that the Allowance for

Doubtful Accounts currently has a $4,314,000 credit balance.

(in thousands)

8-26

After posting, the Allowance

account would look like this . . .

7,196,000$ Desired Balance- 4,314,000 Credit Balance

2,882,000$ Adjusting Entry

7,196,000$ Desired Balance- 4,314,000 Credit Balance

2,882,000$ Adjusting Entry



Accounts


8-27

Notice that the balance after adjustment is equal to the estimate of

$7,196,000 based on the aging analysis performed earlier.

6,043,000 Beg. Bal.Write-offs 1,729,000

4,314,000 Unadj. Bal.2,882,000 AJE7,196,000 Adj. Bal.

Allowance for Doubtful Accounts


8-28

Collections of accounts previously written off require that the original write-off entry be reversed

before the cash collection is recorded.

Let’s record the entry that Skechers would make if $50,000 is collected that had previously been

written off.

Collections of accounts previously written off require that the original write-off entry be reversed

before the cash collection is recorded.

Let’s record the entry that Skechers would make if $50,000 is collected that had previously been

written off.

Debit CreditAccounts Receivable (+A) 50,000

Allowance for Doubtful Accounts (+xA) 50,000

Cash (+A) 50,000 Accounts Receivable (-A) 50,000

Accounts

Other Issues – Account Recoveries

8-29


Compute and report interest on notes

receivable.

8-30

Notes Receivable andInterest Revenue

Accounting for notes receivableAccounting for notes receivableis similar to accounting foris similar to accounting for

accounts receivable except for interest.accounts receivable except for interest.

Accounts receivable do notcharge interest until they

become overdue, but notesreceivable start charging

interest the day they are created.

8-31

Calculating Interest

Even for maturities less than 1 year, the rate is annualized.

Number of months out of twelvethat interest period covers.

8-32

Reporting Interest onNotes Receivable

11/01/07 12/31/07 10/31/08

Recordnote

receivableAccrueinterest

Record interestand principal

received

On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12

percent note. Skechers will receive the principal and all interest earned on October 31, 2008.



2007 Interest 2008 Interest

8-33

Recording Notes Receivable

Debit CreditNote Receivable (+A) 100,000

Cash (-A) 100,000

Accounts

On November 1, to record the note:





8-34

$ 100,000 × 12% × 2/12 = $ 2,000

Interest revenue is $1,000 per month.

Interest revenue is $1,000 per month.

Accruing Interest Earned





8-35

Debit CreditInterest Receivable (+A) 2,000

Interest Revenue (+R, +SE) 2,000

Accounts

On December 31, to accrue $ 2,000 interest receivable:

Accruing Interest Earned





8-36

Debit CreditCash (+A) 112,000

Interest Revenue (+R, +SE) 10,000 Interest Receivable (-A) 2,000 Note receivable (-A) 100,000

Accounts

On October 31, to record $112,000 cash received:





Recording Interest Receivedand Principal at Maturity

8-37

Accounting for Uncollectible Notes

When the collection ofWhen the collection of a note receivable is in doubt, a note receivable is in doubt,a company should record ana company should record an

allowance for doubtful accountsallowance for doubtful accounts against notes receivable just against notes receivable just

as is done with accountsas is done with accountsreceivable.receivable.

8-38


Compute and interpret the

receivables turnover ratio.

8-39

Skechers reported 2005 net credit sales of $1,006,000,000.December 31, 2005, receivables were $134,600,000 and

December 31, 2004, receivables were $120,400,000.

Skechers reported 2005 net credit sales of $1,006,000,000.December 31, 2005, receivables were $134,600,000 and

December 31, 2004, receivables were $120,400,000.

Net Credit Sales Revenue

Average Net Trade Receivables

Receivables Turnover

Ratio=

Receivables Turnover Analysis

8-40

= 7.9 times

$1,006,000,000

($134,600,000 + $120,400,000) ÷ 2=

Boeing Deere & Co. Skechers11.1 6.1 7.9

2005 Receivables Turnover Comparisons

Net Credit Sales Revenue

Average Net Trade Receivables

Receivables Turnover

Ratio=

This ratio measures how many times average receivables are recorded and collected for the year.

This ratio measures how many times average receivables are recorded and collected for the year.


8-41

This ratio tells us the average number of daysit takes a company to collect its receivables.

This ratio tells us the average number of daysit takes a company to collect its receivables.

365 Days

Receivables Turnover Ratio

Days to

Collect=

365 Days

7.9

Days to

Collect= = 46.2 Days

Boeing Deere & Co. Skechers32.9 59.8 46.2

2005 Days-to-Collect Comparisons


8-42

When a company desires to quickly convert receivables into cash, the receivables can be sold to a financing company or bank (called

factoring).

When a company desires to quickly convert receivables into cash, the receivables can be sold to a financing company or bank (called

factoring).

Factoring Receivables

8-43

Credit Card Sales

Companies accept credit cards to:

1. To increase sales.

2. To avoid providing credit directly to customers.

3. To avoid losses due to bad checks.

4. To receive payment quicker.

Companies accept credit cards to:

1. To increase sales.

2. To avoid providing credit directly to customers.

3. To avoid losses due to bad checks.

4. To receive payment quicker.

When credit card sales are made, a fee is paid to the credit card company for the service it provides.

When credit card sales are made, a fee is paid to the credit card company for the service it provides.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 8Supplement

Percentage of Credit Sales Method

8-45

Percentage of Credit Sales

Bad debt percentage is based on actual uncollectible accounts

from prior years’ credit sales.

Focus is on determining the amount to record on the income statement as

Bad Debt Expense.

8-46

Net Credit Sales % Estimated Uncollectible

Amount of Journal Entry

Net Credit Sales % Estimated Uncollectible

Amount of Journal Entry


8-47

In the current year Skechers had credit sales of $1,152,800,000. Past

experience indicates that bad debts are one-fourth of one percent (.25%) of sales.

What is the estimate of bad debt expense for the year?

$1,152,800,000 × .0025 = $2,882,000

Let’s prepare the adjusting entry.


8-48



Accounts


8-49

No journal entries are made until a bad debt is discovered. The following journal entry is made to

record $1,000 of bad debt expense when a customer account is determined to be uncollectible.

No journal entries are made until a bad debt is discovered. The following journal entry is made to

record $1,000 of bad debt expense when a customer account is determined to be uncollectible.

Direct Write-Off Method

Debit CreditBad Debt Expense (+E, -SE) 1,000

Accounts Receivable (-A) 1,000

Accounts

Acceptable for tax purposes,but unacceptable under generally accepted accounting principles.

8-50

End of Chapter 8

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Chapter 8