ACC CH 8

Mechandisers

receivable is recorded at the point of sale of merchandise on account Debit Accounts Recievable Credit Sales -May be reduced by sales discounts and/or sales returns

Similarities

The recording of receivables, of sales returns and allowances, and sales discounts, and the allowance method to record bad debts are the same between GAAP and IFRS. § Both IFRS and GAAP often used the term impairment to indicate that a receivable or a percentage of receivables may not be collected. § The FASB and IASB have worked to implement fair value measurement (the amount they currently could be sold for) for financial instruments, such as receivables. Both Boards have faced bitter opposition from various factions.

Sales of receivable to a factor

common way to accelerate recievables collection is a sale to a factor A factor is a finance company or bank that buys receivables for a fee. Factors collect payments directly from the customers. Factoring fees typically range from 1% to 3% of the amount of receivables purchased. If company usually sells its receivables, it records the service charge as a selling expense. If the company sells its receivables infrequently, it may report the fee under "Other expenses and losses" in the income statement.

Cash (net) realizable value

net amount of cash expected to be recieved -excludes amounts company estimates it will not collect -Recievables are therefore reduced by estimated uncollectible amounts on the balance sheet

Bad Debt Expense

normal and necessary risk of doing business on a credit basis -Direct write off Method -Allowance Method

To Estimate Allowance

o Management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts. o Companies often prepare a schedule in which customer balances are classified by the length of time they have been unpaid. o Because of its emphasis on time, this schedule is often called an aging schedule and the analysis of it is often called aging the accounts receivable. o After the accounts are arranged by age, the expected bad debts losses are determined by applying percentages, based on past experience, to the totals of each category. o The estimated bad debts represent the existing customer claims expected to become uncollectible in the future. o This amount represents the required balance in Allowance for Doubtful Accounts at the balance sheet date. o Accordingly, the amount of the bad debts expense adjusting entry is the difference between the required balance and the existing balance in the allowance account. o Occasionally the allowance account will have a debit balance prior to adjustment because write-offs during the year exceeded the beginning balance in the account. In such a case, the debit balance is added to the required balance when the adjusting entry is made.

There are three reasons for the saleof receivables:

o The size of the receivables may cause a company to sell them because it may not want to hold such a large amount of receivables. In recent years, for competitive reasons, sellers (retailers, wholesalers, and manufacturers) often have provided financing to purchasers of their goods. The purpose is to encourage the sale of the company's product by assuring financing to buyers. o Receivables may be sold because they may be the only reasonable source of cash.When credit is tight, companies may not be able to borrow money in the usual credit markets or the cost of borrowing may be prohibitive. o A final reason for selling receivables is that billing and collection are often time-consuming and costly. As a result, it is often easier for a retailer to sell the receivables to another party that has expertise in billing and collection matters.

Recievable accounts are

one of a company most liquid accounts

Differences

§ Although IFRS implies that receivables with different characteristics should be reported separately, there is no standard that mandates this segregation. § IFRS has a different approach for estimating uncollectible accounts for receivables with a significant financing component (e.g., notes receivable). It differentiates based on whether the receivables have experienced a deterioration in credit quality. § IFRS and GAAP differ in the criteria used to determine how to record a factoring transaction. IFRS is a combination of an approach focused on risks and rewards and loss of control. GAAP uses loss of control as the primary criterion. In addition, IFRS permits partial derecognition of receivables; GAAP does not.

Acceerating Cash Receipts

¨ As credit sales and receivables have grown in size and significance, the "normal course or events" has changed. Two common expressions apply to the collectionof receivables: 1. "Time is money"—that is, waiting for the normal collection process costs money. 2. "A bird in the hand is worth two in the bush"—that is, getting the cash now is better than getting it later or not at all.

Financial Statement Presentation of Recievables

¨ Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. Short-term receivables are reported in the current assets section of the balance sheet below short-term investments. These assets are nearer to cash and are thus more liquid. Both the gross amount of receivables and the allowance for doubtful accounts should be reported. Bad debts expense is reported under "Selling expenses" in the operating expenses section of 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, it is required to discuss this possibility in the notes to the financial statements.

National Credit Card Sales

A common type of credit card is a national credit card such as Visa and MasterCard. Three parties are involved when national credit cards are used in making retail sales: o the credit card issuer, who is independent of the retailer. o the retailer. o the customer. A retailer's acceptance of a national credit card is another form of selling— factoring—the receivable by the retailer. There are several advantages of credit cards for the retailer: o Issuer does credit investigation of customer. o Issuer maintains customer accounts. o Issuer undertakes collection process and absorbs any losses. o Retailer receives cash more quickly from credit card issuer. In exchange for these advantages, the retailer pays the credit card issuer a fee of 2% to 4% of the invoice price for its services. Sales resulting from the use of national credit cards are considered cash sales by the retailer. Upon receipt of credit card sales slips from a retailer, the bank that issued the card immediately adds the amount to the seller's bank balance. *Example: Morgan Marie purchases $1,000 of compact discs for her restaurant from Sondgeroth Music Co., and she charges this amount on her Visa First Bank Card. The service fee that First Bank charges Sondgeroth Music is 3%. The entry by Sondgeroth Music to record this transaction is: Cash 970 Service Charge Expense30 Sales 1,000

Types of Recievables

-Accounts Recievable -Notes Recievable -Other Recievable

Recording the write-off of an uncollectible account

-Each write off should be approved in writing by authorized management personaal -Under the allowance method, every bad debt write off is debited to the allowance account (not to Bad Debt Expense) and credited to the appropriate Accounts Receivable -A write off affects only balance sheet, therefore, remains the same

Other Receivables

-Non trade recievables including interest, loans to company officers, advances to employees, income tax refundable -Classified and reported as separate items in the balance sheet

Two issues with accounts receivable are

-Recognizing accounts receivable -Valuing accounts receivable

Notes Recievable

-Represent claims for which formal instruments of credit are issued as evidence of debits -credit instruments that usually require interest paid 60-90 days or longer -Associated with trade receivables

Recognizing Accounts Receivable

-Service organization -Merchandiser

Accounts Recievable

-amounts customers owe on account -Result from Sales Goods and Services -Expected to be sold 30-60 days -Significant claim held by a company

Three methods of allowance method

1) Companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which revenues are recorded 2) Companies record estimated uncollectible as Debit to Bad Debt Expense Credit Allowance for Doubtful accounts 3) Companies debit actual uncollectible Debit Allowance for Doubtful Credit Accounts Recievable

There are five issues in accounting for notes receivable

1. Determiningthe maturity date. 2. Computinginterest. 3. Recognizingnotes receivable. 4. Valuingnotes receivable. 5. Disposingof notes receivable.

Determining the Maturity Date

1. On demand 2. On a stated date 3. At the end of a stated period of time. -o When life is expressed in terms of months, you find the date when it matures by counting the months from the date of issue. o When due date is stated in terms of days, you need to count the exact number of days to determine the maturity date. In counting, omit the date the note is issued but include the due date.

Recording Estimated Uncollectibles

Allowance for Doubtful Accounts show the estimated amount of claims on customers that are expected to become uncollectible in the future -the credit balance in the allowance account will absorb the specific write offs when they occur -Allowance for Doubtful Accounts is not closed at the end of the fiscal year -Bad debts Expense is reported in the Income Statement as an operating expense (usually a selling expense)

Notes receivable

Apromissory noteis a written promise to pay a specified amount of money on demand or at a definite time. Promissory notes may be used: 1. When individuals and companies lend or borrow money 2. When the amount of the transaction and the credit period exceed normal limits 3. In settlement of accounts receivable

Keeping an eye on cash

Companies with strong sales growth may still have cash problems since there may be a considerable lag time between the time Sales Revenue is recorded and when the amount of cash from that sale is recieved

Computing Interest

The formula for computing interest is: Face Value Note (principal) x Annual Interest Rate x Time (in terms of 1 year)

direct write off method example

Ex* Warden Co. writes off M.E. Dorans $200 balance as uncollectible on December 12 -to record write off of M.E Doran account Debit Bad Debt Expense Credit Accounts Recievable

Estimating the Allowance

If using allowance method, companies must estimate the amount of expected uncollectible accounts as a % of the outstanding recievibles

Evaluating Liquidity of Receivables

Liquidity is measured by how quickly certain assets can be converted into cash -§ The ratio used to assess the liquidity of the receivables is the receivables turnover ratio. § The ratio measures the number of times, on average, receivables are collected during the period. § The receivables turnover ratio is computed by dividing net credit sales (net sales less cash sales) by the average net accounts receivables during the year. § A popular variant of the receivables turnover ratio is to convert it into an average collection periodin terms of days. This is computed by dividing the receivables turnover ratio into 365 days. § The general rule is that the average collection period should not greatly exceed the credit term period (i.e., the time allowed for payment). However if customers pay slowly on credit card sales, the retailer may earn a healthy return on the outstanding receivables in the form of high interest rates. In some cases, receivables turnover may be misleading. Therefore, it is important to know how a company manages its receivables.

Managing Recievables

Managing accounts receivable involves five steps: Determine to whom to extend credit. Establish a payment period. Monitor collections. Evaluate the liquidity of receivables. Accelerate cash receipts from receivables when necessary. § Extending Credit--- Determine to whom to extend credit. o Risky customers might be required to provide letters of credit or bank guarantees. o Particularly risky customers might be required to pay cash on delivery. o Ask potential customers for references from banks and suppliers and check the references. o Periodically check the financial health of continuing customers (Dun and Bradstreet). § Establishing a Payment Period: o Determine a required payment period and communicate that policy to customers. o Make sure company's payment period is consistent with that of competitors. § Monitor collections: o Prepare accounts receivable aging schedule at least monthly. o Pursue problem accounts with phone calls, letters, and legal action if necessary. o Make special arrangements for problem accounts. o If a company has significant concentrations of credit risk, it must discuss this risk in the notes to its financial statements. o Aconcentration of credit riskis a threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company.

Recovery of an Uncollectible Account

When a customer pays after the account has been written off, two or more entries are required -entry made in writing off the account is reversed to reinstate the customers account -collection is then journalized in the usual manner -affects only the balance sheet account

direct write-off method

account is determined to be uncollectible, the loss is charged to bad debt expense -will show actual losses from uncollectible -recorded in a period different from that in revenue is recorded -No attempt to o Match bad debts expense to sales revenue in income statement o Show accounts recievable in balance sheet at amount actually expected to be recieved -can reduce usefulness of both income statement and balance sheet -unless bad debts losses are insignificant, direct write off method is not acceptable for financial reporting purposes

Allowance method

allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of each period -provides better matching of expenses and revenues on the income statement and ensures that receivables are stated in cash(net) realizable value

IFRS

basic accounting and reporting issues related to recognition, measurement, and disposition of receivables, are essentially the same between IFRS and GAAP.

Valuing accounts recievable

determining the amount of accounts receivable to report is difficult because some recievables will become uncollectible -creates bad debt expense

Service Organization

records a receivable when a service is performed on account Debit Accounts Receivable Credit Credit Service Revenue