ACC 2100 - CHAPTER 8
Sale of Receivables
- A common way to accelerate receivables collection is a sale to a factor. A factor is a finance company or a bank that buys receivables from businesses for a fee and then collects the payments directly from the customers. - 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.
Honor of Notes Receivable
- A note is honored when it is paid in full at maturity. - Interest revenue is usually recorded when the note is paid. However, when financial statements are prepared, unrecorded interest revenue that has been earned on notes receivable must be accrued.
Accounts Receivable
- Amounts owed by customers on account. - Result from the sale of goods and services. - Expected to be collected within 30 to 60 days. - Most significant type of claim held by company.
Income Statement Presentation
- 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. - If a company has significant risk of uncollectible accounts or other problems with receivables the situation must be discussed in the notes to the financial statements.
Direct Write-Off Method
- Bad debts losses are not estimated. - No allowance account is used. - Bad debts expense will show only the actual losses from uncollectibles. - Bad debts expense is often recorded in a period different from the period in which the revenue was recorded. - No attempt is made to match bad debts expense to sales revenues in the income statement or to show accounts receivable in the balance sheet at the amount actually expected to be received. - Unless bad debts losses are insignificant, the direct write-off method is not acceptable for financial reporting purposes.
Credit Losses
- Credit losses are considered a normal and necessary risk of doing business. - Such losses are debited to Bad Debt Expense or Uncollectible Accounts Expense.
Establish a payment period
- Determine a required payment period and communicate that policy to customers. - Make sure company's payment period is consistent with that of competitors.
Dishonor of Notes Receivable
- If a note is not paid in full at maturity, it is called a dishonored note. - If there is no hope of collection, the face value of the note should be written off.
Cash (Net) Realizable Value
- Is the net amount expected to be collected in cash. - Excludes amounts the company estimates it will not collect. - Keeps receivables from being overstated on the balance sheet.
Receivables Turnover Ratio
- Measures the number of times, on average, receivables are collected during the period. - Receivables Turnover Ratio = Net Credit Sales / Average Net Receivables - In a popular variant of the receivables turnover ratio, the turnover ratio, the turnover ratio is converted into an average collection period in terms of days. This is computed by dividing the receivables turnover ratio into 365 days. - The collection period should not greatly exceed the credit term period.
Other Receivables
- Non-trade including interest receivable, loans to company officers, advances to employees, and income taxes refundable. - Generally reported as separate items on the balance sheet.
Valuing Notes Receivable
- Notes receivable are reported at their cash realizable value. - The notes receivable allowance account is Allowance for Doubtful Accounts.
Monitor collections
- Prepare accounts receivable aging schedule at least monthly. - Pursue problem accounts with phone calls, letters, and legal action if necessary.
Allowance Method
- Provides better matching on the income statement and ensures that receivables are stated at their cash (net) realizable value. - Cash (net) realizable value is the net amount expected to be received in cash; it excludes amounts that the company estimates it will not collect. - Receivables are therefore reduced by estimated uncollectible receivables on the balance sheet through use of the allowance method. - Required for financial reporting purposes when bad debts are material in amount. 1. Uncollectible accounts receivable are estimated and matched against revenues in the same accounting period in which the revenues occurred. 2. Estimated uncollectibles are recorded as an increase (a debit) to Bad Debts Expense and an increase (a credit) to Allowance for Doubtful Accounts (a contra asset account) through an adjusting entry at the end of each period. 3. Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off as uncollectible.
Notes Receivable
- Represent claims for which formal instruments of credit are issued as evidence of debt. - Credit instrument normally requires payment of interest and extends for time periods of 60-90 days or longer.
Determine to whom credit should be extended
- 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.
Recognizing Accounts Receivable
- Service organizations record accounts receivable when a service has been provided on account. - Merchandisers record accounts receivable at the point of sale of merchandise on account. - Receivables may be reduced by sales discounts and/or sales returns.
Balance Sheet Presentation
- Short-term receivables are reported in the current asset section of the balance sheet below short-term investments. - Both the gross amount of receivables and the allowance for doubtful accounts should be reported. - Notes receivable are listed before accounts receivable because notes are more easily converted to cash.
Three Reasons for the Sale of Receivables
- The first is their size. In recent years, companies often have provided financing to purchasers of their goods. Many major companies have created companies that accept responsibility for accounts receivable financing (i.e., General Motors has General Motors Acceptance Corporation — GMAC, Ford has Ford Motor Credit Corp — FMCC). - Second, receivables may be sold because they may be the only reasonable source of cash. - A final reason for selling receivables is that billing and collection are often time-consuming and costly.
Write-Off of an Uncollectible Account
- When a specific account is considered to be uncollectible it is written off with a debit to the Allowance for Doubtful Accounts - not Bad Debt Expense - and a credit to Accounts Receivable. - A write-off decreases a receivable, and the Allowance for Doubtful Accounts... - But the cash realizable value remains the same - no changes.
Determining the Maturity Date
- When the life of the note is expressed in terms of days, you need to count the days. - In counting, the date of issue is omitted but the due date is included.
Notes Receivable
- When the life of the note is expressed in terms of months, the due date is found by counting the months from the date of issue. - Example: The maturity date of a 3-month note dated May 31 is August 31.
Managing Receivables
1. Determine to whom to extend credit. 2. Determine a payment period. 3. Monitor collections. 4. Evaluate the liquidity of receivables. 5. Accelerate cash receipts from receivables.
Computation of Interest
Interest rate specified on a note is an annual rate of interest.
Accounting for Uncollectible Accounts
Methods to account for uncollectible accounts: - Direct Write-Off Method - Allowance Method
Types of Receivables
Receivables refers to amounts due from individuals and companies. They are claims expected to be collected in cash. Receivables are frequently classified as: - Accounts receivable - Notes receivable - Other receivables
Computing Interest
The formula for computing interest is: - Face (principal) × Rate (interest) × Time