ACC 212: Chapter 8- Receivables, bad debt expense, and interest revenue

The four key events that occur with any note receivable are

(1) establishing the note, (2) accruing interest earned but not received, (3) recording interest payments received, and (4) recording principal payments received.

Two objectives when accounting for accounts receivable and bad debts are to

(1) report Accounts Receivable at the amount the company expects to collect ("net realizable value") and (2) match the cost of bad debts to the accounting period in which the related credit sales are made. -These two objectives point to the same solution: Reduce both Accounts Receivable and Net Income by the amount of credit sales that are unlikely to be collected.

(called the maturity date).This usually happens in the following three situations:

(1) the company loans money to employees or businesses, (2) the company sells expensive items for which customers require an extended payment period, or (3) the company converts an existing account receivable to a note receivable to allow an extended payment period.

Increased wage costs. : If credit is extended, VFC will have to hire people to

(a) evaluate whether each customer is creditworthy, (b) track how much each customer owes, and (c) follow up to collect the receivable from each customer

A company reports Notes Receivable if it uses a promissory note to document its right to collect money from another party and intends to retain that right until a specified future date

(called the maturity date).

The disadvantages of extending credit are the following additional costs introduced:

-Increased wage costs -bad debt costs -Delayed receipt of cash

Aging of Account Receivable Method

-uses more data and is more accurate -estimates uncollectible accounts based on the age of each account receivable

To calculate interest, you need to consider three variables:

1) the principal, which is the amount of the note receivable; (2) the annual interest rate charged on the note; and (3) the time period covered in the interest calculation.

Aging of Account Receivable Method steps

1- prepare an aged listing of account receivable 2- estimate bad debt loss percentages for each aging category 3- compute the total estimate by multiplying the totals in step(1) by the percentages in step (2) and then summing across all categories

the accounting records can be adjusted when uncollectible amounts become known with near certainty. This approach is called the allowance method and it follows a two-step process, which we'll walk you through below:

1. Record the estimated bad debts in the period credit sales occur, using an end-of-period adjustment, and 2.Remove ("write off") specific customer balances when they are known to be uncollectible.

four event happen with note receivable

1. establish the note 2. accue interest 3. record interest received 4, record principal received

Which of the following statements about the receivables turnover ratio is true?

A higher receivables turnover ratio means faster (better) turnover.

This adjustment, which is made at the end of each accounting period, reduces

Accounts Receivable (using a contra-asset account called Allowance for Doubtful Accounts) and reduces Net Income (using an expense account called Bad Debt Expense).

Use the following interest formula to calculate the interest:

Interest (I) = Principal (P) ✕ Interest Rate (R) ✕ Time (T)

For billing and collection purposes,

Keeps a separate accounts receivable account (called a subsidiary account)or each customer. The total of these accounts is reported as Accounts Receivable on the balance sheet

Another way to avoid lengthy collection periods is to allow customers to pay for goods using

PayPal or national credit cards like Visa, MasterCard, American Express, and Discover Card. Unlike private credit card programs, where the seller pursues collection from customers, national credit card companies and PayPal pay the seller within one to three days of the sale. Most banks process authorized credit card transactions as if they are overnight deposits of cash into the company's bank account.

Which of the following is the term used to describe the process of selling and collecting?

Receivables turnover

percentage of sales method

Simpler to apply A method of advertising budget allocation based on a percentage of the previous year's sales, the anticipated sales for the next year, or a combination of the two.

Which of the following statements about the days to collect is true?

The days to collect measures the average number of days from sale on account to collection.

Notice a receivable write-off does not affect income statement accounts.

The estimated Bad Debt Expense relating to these uncollectible accounts was already recorded with an adjusting entry in the period the sale was recorded. Therefore, no additional expense is incurred when the account is finally written off

Bad debt costs. Inevitably, some customers dispute what they owe, or they run into financial difficulties and pay only a fraction of their account balances.

These "bad debts," as they are called, can be a significant additional cost of extending credit. At September 30, 2016, VFC estimated that more than $22 million of its receivables would not be collected.

Delayed receipt of cash. Even if VFC were to collect in full from customers, it would likely have to wait 30-60 days before receiving the cash. During this period,

VFC may have to take out a short-term bank loan to pay for other business activities. The interest on such a loan would be another cost of extending credit to customers.

Throughout the year, when it becomes clear a particular customer will never pay,

VFC removes the customer's account from the accounts receivable records.

If VFC were to remove the specific customer accounts believed to be uncollectible, it would lose track of which customers still owed money. If this were to happen,

VFC would no longer know which customers it should continue pursuing for payment.

Removing the uncollectible account and a corresponding amount from the allowance is called

a receivable write-off.

Most managers find the additional revenue (or, more accurately, the gross profit) from selling on

account to business customers is greater than the additional costs mentioned above.

we need to record bad debts in the same period as the sale. The only way to do this is to record

an estimate of the amount of bad debts that are likely to arise.

VFC allows business customers (like Walmart and Macy's) to open an account

and buy items on credit, yet its outlet stores do not extend this option to you—the individual consumer.

The percentage of credit sales method estimates bad debt expense

by multiplying the estimated percentage of bad debt losses by the current period's credit sales

Although the Allowance for Doubtful Accounts normally has a credit balance, it may have a debit balance before it is adjusted. This happens when a

company has recorded write-offs that exceed previous estimates of uncollectible accounts.If this happens, you can still calculate the amount of the adjustment needed to reach the desired balance under the aging of accounts receivable method

The reason VFC is willing to create an account receivable from business customers but not individual consumers is that

doing so involves different advantages and disadvantages.

Such estimates may be based on

either (1) a percentage of credit sales for the period or (2) an aging of accounts receivable. Both methods are acceptable under GAAP and IFRS

The accounting issues for notes receivable are similar to those for accounts receivable, with one exception. Unlike accounts receivable, which are interest-free until they become overdue, notes receivable charge

interest from the day they are created to their maturity date.

What accounts are included in the entry to accrue interest earned but not yet received?

interest receivable interest revenue

Under accrual basis accounting,

interest revenue is earned over time. Rather than record the interest earned as each day passes, VFC waits until it either receives an interest payment or reaches the end of its accounting period.

calculating interest on a note receivable

interest= principal x interest Rate x Time

A low turnover ratio can be a warning sign, suggesting the company .

is allowing too much time for customers to pay. As you learned earlier in this chapter (in the Spotlight), the longer an account goes uncollected, the bigger the risk it will never be collected

The advantage of extending credit

is that it helps business customers buy products and services, thereby increasing the seller's revenues.

The purpose of writing off some or all of a customer's account balance .

is to remove amounts that have virtually no chance of collection.

The aging method gets its name because

it is based on the "age" of each amount in Accounts Receivable.

The reason is, at the time the Allowance for Doubtful Accounts is estimated,

no one knows which particular customers' accounts receivable are uncollectible.

The receivables turnover ratio indicates how many times,

on average, this process of selling and collecting is repeated during the period.

Whereas the percentage of credit sales method focuses

on estimating this period's Bad Debt Expense, the aging of accounts receivable method focuses on estimating the Allowance for Doubtful Accounts ending balance

By removing the receivable, VFC no longer needs to make an allowance for it,

so the company removes the corresponding amount from the Allowance for Doubtful Accounts.

Interest rates are always stated as an annual percentage (even if the note is for more or less than a year),

so the time period factor is the portion of a year for which interest is calculated. It is a fraction expressed as the number of months out of 12, or days out of 365, the interest period covers using the interest formula

Although interest on a note receivable is earned each day, interest payments typically are received only once or twice a year. This means

that a company with a note receivable needs to accrue Interest Revenue and Interest Receivable. Let's look at how to calculate interest.

Credit sales, when first recorded, affect both

the balance sheet (an increase in Accounts Receivable) and the income statement (an increase in Sales Revenue).

The higher the ratio,

the faster the collection of receivables. And the faster the collection of receivables, the shorter your company's operating cycle, which means more cash available for running the business.

The older and more overdue an account receivable becomes, .

the less likely it is to be collectible. Based on this idea, credit managers and accountants use their experience and economic forecasts to estimate what portion of receivables of a specific age will not be paid

Receivables turnover ratios and the number of days to collect often are used

to compare companies, but be aware they can vary across industries.

Thus, to account for any bad credit sales that have been included in Sales Revenue and Accounts Receivable,

we record offsetting amounts in both the balance sheet and income statement.