ACC 101, Course Lectures

ACCOUNTING FOR ACCOUNTING FOR RECEIVABLESRECEIVABLES

CHAPTERCHAPTER

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• The term receivables refers to amounts due from individuals and other companies; they are claims expected to be collected in cash.• Three major classes of receivables are:

1. Accounts Receivable 2. Notes Receivable 3. Other Receivables

RECEIVABLESRECEIVABLES

The three primary accounting problems associated with accounts receivable are:1. Recognizing accounts receivable.2. Valuing accounts receivable.3. Disposing of accounts receivable.

ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

July 11,000

To record sales on account.

1,000

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

Accounts Receivable - Adorable JuniorSales

RECOGNIZING RECOGNIZING ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

When a business sells merchandise to a customer on credit, Accounts Receivable is debited and Sales is credited.

100


When a business receives returned merchandise previously sold to a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited.


July 5Sales Returns and Allowances Accounts Receivable - Adorable 100

To record merchandise returned.

900



July 31Cash ($1,000 - $100) Accounts Receivable - Adorable 900

To record collection of account.

When a business collects cash from a customer for merchandise previously sold on credit, Cash is debited and Accounts Receivable is credited.

13.50



July 31Accounts Receivable - Adorable Interest Revenue 13.50

To record interest on amount due.

When financing charges are added to a balance owing, Accounts Receivable is debited and Interest Revenue is credited.

• To ensure that receivables are not overstated on the balance sheet, they are stated at their net realizable value.

• Net realizable value is the net amount expected to be received in cash and excludes amounts that the company estimates it will not be able to collect.

VALUING VALUING ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLE

• Two methods of accounting for uncollectible accounts are:

1. Allowance method

2. Direct write-off method

VALUINGVALUING ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

• Under the direct write-off method, no entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to Bad Debts Expense.

• No attempt is made to match bad debts to sales revenues or to show the net realizable value of accounts receivable on the balance sheet.

DIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHOD


Jan. 12 Bad Debts Expense Accounts Receivable — E. Schaefer

For write-off of E. Schaefer account.

DIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHOD

Periera Company writes off E. Schaefer’s $200 balance as uncollectible on January 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles.

200 200

• The allowance method is required when bad debts are deemed to be material in amount.

• Uncollectible accounts are estimated and the expense for the uncollectible accounts is matched against sales in the same accounting period in which the sales occurred.

THE ALLOWANCE METHODTHE ALLOWANCE METHOD

Estimated uncollectible amounts are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts (a contra asset account) at the end of each period.


Date Account Title and Explanation Debit CreditDec. 31 Bad Debts Expense 24,000

Allow ance for Doubtful Accounts 24,000 To record estim ate of uncollectible accounts.

GENERAL JOURNAL

ADORABLE JUNIOR GARMETBalance Sheet (partial)

Current assets Cash $ 14,800

Accounts receivable $200,000Less: Allowance for doubtful accounts 24,000 188,000

Net Realizable Value


Mar. 1Allowance for Doubtful Accounts Accounts Receivable — Nadeau

Write-off of Nadeau account.

Actual uncollectible accounts are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.


500 500

When there is recovery of an account that has been written off: 1. reverse the entry made to write off the account and ...



July 1Accounts Receivable — Nadeau Allowance for Doubtful Accounts

To reverse write-off of Nadeau account.

500 500



July 1 Cash Accounts Receivable —Nadeau

To record collection from Nadeau.

500 500

2. Record the collection in the usual manner.

• Companies use either of two methods in the estimation of uncollectible accounts:1. Percentage of sales2. Percentage of receivables

• Both bases are GAAP; the choice is a management decision.

BASES USED FOR THE ALLOWANCE BASES USED FOR THE ALLOWANCE METHODMETHOD

ILLUSTRATION ILLUSTRATION 9-49-4 COMPARISON OF COMPARISON OF

BASES OF ESTIMATING BASES OF ESTIMATING UNCOLLECTIBLESUNCOLLECTIBLES

Percentage of Sales Percentage of ReceivablesNet Realizable Value

AllowanceAccounts forReceivable Doubtful

Accounts

Emphasis on Income Statement

RelationshipsEmphasis on Balance Sheet Relationships

• In the percentage of sales basis, management establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts.

• Expected bad debt losses are determined by applying the percentage to the sales base of the current period.

• This basis better matches expenses with revenues.

PERCENTAGE OF SALES BASISPERCENTAGE OF SALES BASIS

• Under the percentage of receivables basis, management establishes a percentage relationship between the amount of accounts receivable and the required balance in the allowance account.

• This percentage can be applied to the total accounts receivable balance, or to individual accounts receivable balances stratified by age.

PERCENTAGE OF PERCENTAGE OF RECEIVABLES BASISRECEIVABLES BASIS

• The required balance in the allowance account is determined by applying the percentage to the accounts receivable balance at the end of the current period.

• The amount of the adjusting entry to record expected bad debt losses for the current period is the difference between the required balance and the existing balance in the allowance account.

• This basis produces the better estimate of net realizable value of receivables.

PERCENTAGE OF PERCENTAGE OF RECEIVABLES BASISRECEIVABLES BASIS

To accelerate the receipt of cash from receivables, owners frequently:

1. sell to a factor, such as a finance company or a bank, and

2. make credit card sales.

DISPOSING OF DISPOSING OF ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

• A factor buys receivables from businesses for a fee and collects the payments directly from customers.

• Credit cards are frequently used by retailers who wish to avoid the paperwork of issuing credit.

• Retailers can receive cash more quickly from the credit card issuer.

DISPOSING OF DISPOSING OF ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

• Three parties are involved when credit cards are used in making retail sales:1. the credit card issuer,2. the retailer, and3. the customer.

• The retailer pays the credit card issuer a percentage fee of the invoice price for its services.

• From an accounting standpoint, sales from bank cards (e.g., Visa and MasterCard) are treated differently than sales from non-bank cars (e.g., American Express).

CREDIT CARD SALESCREDIT CARD SALES

BANK CARD SALESBANK CARD SALES

• Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer.

• These cards are issued by banks.• Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller’s bank balance.


July 31 CashCredit Card Expense ($1,000 x 3.5%) Sales

To record VISA credit card sales.

BANK CARD SALESBANK CARD SALES

Anita Ferreri purchases a number of compact discs for her restaurant from Karen Kerr Music Co. for $1,000 using her Royal Bank VISA card. The service fee that the Royal charges is 3.5 percent.

965 35 1,000

NON-BANK CARD SALESNON-BANK CARD SALES

• Sales using American Express and other non-bank cards are reported as credit sales, not cash sales.

• Conversion into cash does not occur until American Express remits the net amount to the seller.

NON-BANK CARD SALESNON-BANK CARD SALES

Kerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent.


July 31 Accounts ReceivableCredit Card Expense ($500 x 5%) Sales

To record American Express credit card sales.

475 25 500

• A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.

• The party making the promise is the maker.

• The party to whom payment is made is called the payee.

NOTES RECEIVABLENOTES RECEIVABLE

The basic formula for calculating interest on an interest-bearing note is:

The interest rate specified on the note is an annual rate of interest.

ILLUSTRATION ILLUSTRATION 9-89-8 FORMULA FOR FORMULA FOR

CCALCULATALCULATING INTERESTING INTEREST

Face Valueof Note

Annual InterestRate

Timein Terms of One Year

InterestX X =


May 1Notes Receivable Accounts Receivable — Brent Company

To record acceptance of Brent Company note.

RECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLE

Wilma Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company to settle an open account.

1,000 1,000

• Like accounts receivable, short-term notes receivable are reported at their net realizable value.

• The notes receivable allowance account is Allowance for Doubtful Notes.

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLE

HONOUR OF NOTES RECEIVABLEHONOUR OF NOTES RECEIVABLE

•A note is honoured when it is paid in full at its maturity date.

•Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5% interest-bearing note, due in 4 months, on September 30.

• Wolder collects the maturity value of the note from Higley on September 30.

Date Account Title and Explanation Debit CreditSept. 30 Cash 10,150

Notes Receivable - Higly 10,000 Interest Revenue 150 To record collection of Higly note.

GENERAL JOURNAL

DISHONOUR OF NOTES RECEIVABLEDISHONOUR OF NOTES RECEIVABLE

•A dishonoured note is a note that is not paid in full at maturity.• A dishonoured note receivable is no longer negotiable.• Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable.

Date Account Title and Explanation Debit CreditSept. 30 Accounts Receivable - Higly 10,150

Notes Receivable - Higly 10,000 Interest Revenue 150 To record the dishonour of Higly note.

GENERAL JOURNAL

BALANCE SHEET PRESENTATION OF BALANCE SHEET PRESENTATION OF RECEIVABLESRECEIVABLES

• Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements.

• In the balance sheet, short-term receivables are reported within the current assets section below cash and temporary investments.

• Both the gross amount of receivables and the allowance for doubtful accounts should be reported.

USING THE INFORMATION IN THE USING THE INFORMATION IN THE FINANCIAL STATEMENTSFINANCIAL STATEMENTS

• Financial ratios are calculated to evaluate the short-term liquidity of a company.

• These ratios include the1. current ratio,2. acid test (quick) ratio,3. receivables turnover ratio, and the4. collection period ratio.

CURRENT RATIOCURRENT RATIO

CURRENT ASSETS CURRENT RATIO = ——————————— CURRENT LIABILITIES

• The current ratio (working capital ratio) is a widely used measure for evaluating a company’s liquidity and short-term debt-paying ability.

CASH + TEMPORARY INVESTMENTS + RECEIVABLES (NET) ACID TEST RATIO = ————————————————————————————

CURRENT LIABILITIES

ACID TEST RATIOACID TEST RATIO

• The acid test ratio (quick ratio) is a measure of a company’s short-term liquidity.

ACCOUNTS RECEIVABLE TURNOVER ACCOUNTS RECEIVABLE TURNOVER RATIORATIO

• The ratio used to assess the liquidity of the receivables is the receivables turnover ratio.

Net Credit Average Net Receivables

Sales Receivables Turnover

=

COLLECTION PERIODCOLLECTION PERIOD

• The collection period in days is a variant of the receivables turnover ratio and makes liquidity even more evident.

• The general rule is that the collection period should not exceed the credit term period.

Days in Year Receivables Collection

(365) Turnover Period in Days

=

ACC 101, Course Lectures

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