Accounts and Bills Receivable Chapter 8 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT.

Accounts and Bills Receivable

Chapter 8

HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

8 - 2Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia

Objectives

1.Design internal controls for receivables

2.Use the provision method to account for bad debts by the percentage of sales and aging of accounts method

3.Use the direct write off method to account for bad debts

4.Accounts for bills receivable

5.Report receivables on the financial statements

6.Use the acid-test ratio and days’ sales in receivables to evaluate a firms financial position


Accounts receivable(Trade receivables)

Receivables

Bills receivable(Notes receivable)


Design internal controls

for receivables.

Objective 1


Establishing Internal Control

What are some controls over accounts receivable?

Separationof dutiesSeparationof duties

Approval for write-off

Approval for write-off

Control overmail receiptsControl overmail receipts


The Credit Department

Companies grant credit to customers in order to increase sales.

The credit department evaluates customers who apply for credit cards.


Accounting for Bad Debts

Provision method

Direct write-off method


Use the provision methodto account for bad debts

by the percent of sales and aging of accounts method.

Objective 2


Methods for Estimating Bad Debts

Percentage of Sales

Aging of Accounts Receivable


Percentage of Sales

This is also called the statement of financial performance approach.

It is based on prior experience of the business.

It is calculated as a percentage of credit sales.

It ignores the current balance of the provision account.

The percentage used is adjusted as needed to reflect collection experience.


Percentage of Sales Example

The credit department of Anna’s Boutique estimates (based on prior experience) that 1% of net credit sales are uncollectible.

Net credit sales for the year just ended were $500,000.

What is the adjusting entry? $500,000 × 1% = $5,000



June 30, 2004

Bad Debts Expense 5,000Provision for Bad debts 5,000

Recorded bad debts expense for the year

June 30, 2004

Bad Debts Expense 5,000Provision for Bad debts 5,000

Recorded bad debts expense for the year


Decrease inNet ProfitsDecrease inNet Profits

Decrease in netAccounts Receivable

Decrease in netAccounts Receivable

What is the effect of this adjusting entry?What is the effect of this adjusting entry?



Aging of Accounts Receivable

This approach is also called the statement of financial position approach because it focuses on accounts receivable.

Individual accounts receivable from specific customers are analysed according to the length of time they remain outstanding.


Aging of Receivables Example

Assume that International Hospital’s past collection experience indicates the following:

Length of time % uncollectible 1-30 days 2.0 31-60 days 3.0 61-90 days 5.0 90 + days 8.0


AccountsReceivable

Provision for Bad Debts

Length Amount %1-30 $1,900,000 2 $

38,00031-60 1,000,000 3 30,00061-90 700,000 5 35,00090 + 500,000 8

40,000Total $4,100,000

$143,000




The provision account is adjusted to this $143,000 balance:

Assume that the account currently has a credit balance of $100,000.

What is the adjustment?


June 30

Bad debts Expense 43,000Provision for Bad debts 43,000

To record the provision for bad debts

June 30

Bad debts Expense 43,000Provision for Bad debts 43,000

To record the provision for bad debts

What if the account had adebit balance of $1,000?What if the account had adebit balance of $1,000?

Aging of Receivables



Adjustment 1,000 144,000

Adjusted balance 143,000


Adjustment 1,000 144,000

Adjusted balance 143,000

Aging of Receivables


Comparing the Percentage of Sales

and Aging MethodsProvision Method

Percent of Sales Method Aging of Accounts Receivable Method

Adjusts Provision For Bad Debts

Adjusts Provision For Bad debts

BY TO

BAD DEBTSEXPENSE

EXPECTED UNCOLLECTABLEACCOUNTS RECEIVABLE

Amount of Amount of


Writing OffBad Debts

What happens when it becomes apparent that an account will not be collected?

It must be written off. How?

Debit Provision for Bad Debts.

Credit Accounts Receivable.


Recoveries

How is the collection of a previously written- off account recorded?

Debit Accounts Receivable (to reinstate the account).

Credit Provision for Bad Debts. Then

Debit Cash.

Credit Accounts Receivable (to record the collection).


Use the direct write-off methodto account for bad debts.

Objective 3


Direct Write-Off Method

Using this method, an account is written off only when it becomes uncollectible.

No provision account is created. This method is simple to use – but: The statement of financial position is

overstated. The statement of financial performance

is understated.


Credit Card and Bankcard Sales

These save retailers the cost of a credit department.

The retailer is required to pay a fee (called a discount) for usage.


Credit Card and Bankcard Sales

How would Anna’s Boutique record a $100 credit card sale with a 3% service charge?

Accounts Receivable (credit card) 97Credit Card Charge 3

Sales Revenue 100

To record a credit card sale of $100less a 3% service charge fee

Accounts Receivable (credit card) 97Credit Card Charge 3

Sales Revenue 100

To record a credit card sale of $100less a 3% service charge fee


Debit Card Sales

Using a debit card is like

paying with cash.

Using a debit card is like

paying with cash.


Bills Receivable: an Overview

A bill receivable may arise from a sale or may be given in settlement of an account receivable.

The ‘Acceptor’ pays the ‘Drawer’ the maturity value.

The maturity value is paid on the maturity date and includes principal plus interest.

See Exhibit 8-5 page 342 of the textbook


Identifying a Bill’sMaturity Date

When the period is given in days…– the maturity date is determined by counting

the days from the date of issue. When the period is given in months… – the maturity date is on the same day of the

month as the date the bill was issued. Although the period of the bill is usually less

than one year interest rates are usually stated as an annual rates.


Principal × Rate × Time = InterestPrincipal × Rate × Time = Interest

$10,000 × 10% × 90 ÷ 360 = $246.58$10,000 × 10% × 90 ÷ 360 = $246.58

Calculating Interest on a Bill

Calculate interest on the bill due to State Bank.Principal: $10,000Interest: 10%Time: June 1, 2004, to August 29, 2004

Calculate interest on the bill due to State Bank.Principal: $10,000Interest: 10%Time: June 1, 2004, to August 29, 2004


Account for bills receivable.

Objective 4


Recording Bills Receivable

Assume the accounting period ended June 30.

How much interest was earned by the bank as of June 30?

$10,000 × 10% × (30* ÷ 365) = $82.19

[* 30 days from June 1 to June 30]



June 30

Interest Receivable 82.19Interest Revenue82.19

To accrue interest on the bill

June 30

Interest Receivable 82.19Interest Revenue82.19

To accrue interest on the bill



How does the bank record the collection at maturity?

August 29

Cash 10,246.58Bill Receivable

10,000.00Interest Receivable

82.19Interest Revenue

164.39

Record interest on bill

August 29


10,000.00Interest Receivable

82.19Interest Revenue

164.39



Discounting a Bill Receivable

The drawer (one who will receive the money) may sell (discount) a bill so they receive money now, rather than at maturity.

From the previous example State Bank discounts the bill on June 21, discount rate is 12% (this is not the actual interest rate).

$10,246.58 × 12% × 70* / 365 = $235.81

[*70 days is June 21 to August 29]


Discounting a Bill Receivable

How does the bank record the discounting?

June 21


10,000.00Interest Revenue

10.77


June 21


10,000.00Interest Revenue

10.77

Record interest on bill$10.77 = $10,246.58 - $235.81$10.77 = $10,246.58 - $235.81


Dishonored Bills Receivable

If the maker of the bill fails to pay the maturity value to the new payee, then the original payee legally must pay the bank the amount due (unless the discounting is without recourse).

This gives rise to a contingent liability for the drawer when they discount a bill.


Report receivables on the statement of financial position

Objective 5


Reporting Receivables

Some companies report a single amount for its current receivables in the body of the statement of financial position.

They use a note to the financial statements to give more details.

See Qantas example pages 346-47 text.


Use the acid-test ratio and days’sales in receivables to evaluate

a firm’s financial position.

Objective 6


Acid-test ratio = (Cash + Short-term investments+ Net current receivables) ÷ Total current liabilities

Acid-test ratio = (Cash + Short-term investments+ Net current receivables) ÷ Total current liabilities

Acid-Test Ratio

This is a stringent test of liquidity than the current ratio.

It measures the entity’s ability to pay its current liabilities immediately.


Days’ Sales in Receivables

It is a measure of the time it takes to collect receivables.

A smaller number indicates a quick conversion to cash.


One day’s sales = Net sales ÷ 365 daysOne day’s sales = Net sales ÷ 365 days

Days’ sales in average accounts receivable =Average net accounts receivable ÷ One day’s sales

Days’ sales in average accounts receivable =Average net accounts receivable ÷ One day’s sales

Days’ Sales in Receivables


End of Chapter 8

Accounts and Bills Receivable Chapter 8 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT.

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