Chapter 8: Reporting and Analyzing Receivables

Equation to Compute Interest on an interest-bearing note

(face value of note) x (annual interest rate) x (time in terms of a year, months passed, or days passed) = interest

Types of Receivables

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

3 features of the Allowance Method for uncollectible accounts

1. Companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded. 2. Companies record estimated uncollectibles as an increase (a debit) to Bad Debt Expense and an increase (a credit) to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts Receivable. 3. Companies debit actual uncollectibles to Allowance for Doubtful Accounts and credit them to Accounts Receivable at the time the specific account is written off as uncollectible.

Factor

A finance company or bank that buys receivables from businesses for a fee and then collects the payments directly from the customers.

Promissory note

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

Indicate which type of receivable should be recorded Sold goods to a customer on account for $5,000.

Accounts Receivable

Explain how accounts receivable are recognized in the accounts.

Companies record accounts receivable when they perform a service on account or at the point-of-sale of merchandise on account. Sales returns and allowances, and cash discounts reduce the amount received on accounts receivable.

Explain the statement presentation of receivables.

Companies should identify each major type of receivable in the balance sheet or in the notes to the financial statements. Short-term receivables are considered current assets. Companies report the gross amount of receivables and allowance for doubtful accounts. They report bad debt and service charge expenses in the income statement as operating (selling) expenses, and interest revenue as other revenues and gains in the nonoperating section of the statement.

What are the accounting methods used to book uncollectible accounts?

Direct write-off method for uncollectible accounts Allowance method for uncollectible accounts

To record the reverse write-off and collection of an account under the allowance method

Dr. Accounts Receivable Cr. Allowance for Doubtful Accounts Dr. Cash Cr. Accounts Receivable

To record interest of the amount due

Dr. Accounts Receivable Cr. Interest Revenue

To record sales on account

Dr. Accounts Receivable Cr. Sales Revenue

To record the write-off of an account under the allowance method

Dr. Allowance for Doubtful Accounts Cr. Accounts Receivable

To record collection of accounts receivable

Dr. Cash Dr. Sales Discounts Cr. Accounts Receivable

Describe methods to accelerate the receipt of cash from receivables.

If the company needs additional cash, management can accelerate the collection of cash from receivables by selling (factoring) its receivables or by allowing customers to pay with bank credit cards.

Indicate which type of receivable should be recorded Accepted a $2,000 promissory note from a customer as payment on account.

Notes Receivable

Trade receivables

Notes and accounts receivable that result from sales transactions.

Describe the entries to record the disposition of notes receivable.

Notes can be held to maturity, at which time the borrower (maker) pays the face value plus accrued interest and the payee removes the note from the accounts. In many cases, however, similar to accounts receivable, the holder of the note speeds up the conversion by selling the receivable to another party. In some situations, the maker of the note dishonors the note (defaults), and the note is written off.

Indicate which type of receivable should be recorded Advanced $1,000 to a trusted employee.

Other Receivables

Indicate which type of receivable should be recorded Determined that a $10,000 income tax refund is due from the IRS.

Other Receivables

Indicate which type of receivable should be recorded Loaned a company officer $4,000.

Other Receivables

Indicate which type of receivable should be recorded Recorded $500 accrued interest on a note receivable due next year.

Other Receivables

Identify the different types of receivables.

Receivables are frequently classified as accounts, notes, and other. Accounts receivable are amounts customers owe on account. Notes receivable represent claims that are evidenced by formal instruments of credit. Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable.

Notes receivable

Written promise (as evidenced by a formal instrument) for amounts to be received.

Other receivables

include nontrade receivables such as... Interest receivable Loans to company officers Advances to employees Income taxes refundable These do not generally result from the operations of the business.

5 issues in recognizing notes receivable

1. Determining the maturity date. 2. Computing interest. 3. Recognizing notes receivable. 4. Valuing notes receivable. 5. Disposing of notes receivable.

Accounts receivable turnover

A measure of the liquidity of accounts receivable, computed by dividing net credit sales by average net accounts receivable.

Allowance method

A method of accounting for bad debts that involves ESTIMATING uncollectible accounts at the END of each period. Provides better matching of expenses with revenues on the income statement Ensures that receivables are stated at their cash (net) realizable value on the balance sheet

Direct write-off method

A method of accounting for bad debts that involves charging receivable balances to Bad Debt Expense at the time receivables from a particular company are determined to be uncollectible. under this method, bad debt expense will show only ACTUAL losses for bad debts, there are no estimates ***the direct write-off method is not acceptable for financial reporting purposes

Percentage-of-receivables basis

A method of estimating the amount of bad debt expense whereby management establishes a percentage relationship between the amount of receivables and the expected losses from uncollectible accounts.

Dishonored (defaulted) note

A note that is not paid in full at maturity.

Aging the accounts receivable

A schedule of customer balances classified by the length of time they have been unpaid.

Accounts receivable

Amounts customers owe on account.

Receivables

Amounts due from individuals and companies that are expected to be collected in cash.

Bad Debt Expense

An expense account to record losses from extending credit.

To record estimates of uncollectible accounts under the allowance method

Dr. Bad Debt Expense Cr. Allowance for Doubtful Accounts

To adjust allowance account to total estimated collectibles???

Dr. Bad Debt Expense Cr. Allowance for Doubtful accounts The amount of bad debt expense that should be recorded in the adjusting entry is the difference between the required balance and the existing balance in the allowance account

To record write-off of an account under the direct write-off method

Dr. Bad Debt Expense Cr. Accounts Receivable

To record the collection of a note and interest

Dr. Cash Cr. Notes Receivable Cr. Interest Receivable Dr. Interest Revenue

To record the honor/collection of a note and its interest

Dr. Cash Cr. Notes Receivable Cr. Interest Revenue

To record the sale of receivables to a factor

Dr. Cash Dr. Service Charge Expense Cr. Accounts Receivable

To record Visa credit card Sales

Dr. Cash Dr. Service Charge Expense Cr. Sales Revenue

To accrue interest on a note

Dr. Interest Receivable Cr. Interest Revenue

To record the acceptance of a note

Dr. Notes Receivable Cr. Accounts Receivable

To record merchandise returned

Dr. Sales Returns and Allowances Cr. Accounts Receivable

Identify ratios to analyze a company's receivables.

The accounts receivable turnover and the average collection period both are useful in analyzing management's effectiveness in managing receivables. The accounts receivable aging schedule also provides useful information.

Average collection period

The average amount of time that a receivable is outstanding, calculated by dividing 365 days by the accounts receivable turnover.

Compute the interest on notes receivable.

The formula for computing interest is: (face value of note) x (annual interest rate) x (time in terms of a year, months passed, or days passed) = interest

Cash (net) realizable value

The net amount a company expects to receive in cash from receivables.

Maker

The party in a promissory note who is making the promise to pay.

Payee

The party to whom payment of a promissory note is to be made.

Concentration of credit risk

The threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company.

Describe the methods used to account for bad debts.

The two methods of accounting for uncollectible accounts are the allowance method and the direct write-off method. Under the allowance method, companies estimate uncollectible accounts as a percentage of receivables. It emphasizes the cash realizable value of the accounts receivable. An aging schedule is frequently used with this approach.

Describe the principles of sound accounts receivable management.

To properly manage receivables, management must (a) determine to whom to extend credit, (b) establish a payment period, (c) monitor collections, (d) evaluate the liquidity of receivables, and (e) accelerate cash receipts from receivables when necessary.