Accounting - C8 - Reporting and Analyzing Receivables

3 Types of Receivables

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

What are the 3 essential features of the Allowance Method?

1. Companies estimate uncollectible accounts receivable. They match this estimated expense against revenues in the same accounting period in which they record the revenues. 2. Companies debit estimated uncollectibles to Bad Debt Expense and credit them 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. When companies write off a specific account, they debit actual uncollectibles to Allowance for Doubtful Accounts and credit that amount to Accounts Receivable.

What are the five steps in managing accounts receivable?

1. Determine to whom to extend credit. 2. Establish a payment period. 3. Monitor collections - using accounts receivable aging schedule to estimate allowance for doubtful accounts; identifying concentration of credit risk 4. Evaluate the liquidity of receivables. 5. Accelerate cash receipts from receivables when necessary.

What are two issues specific to notes receivable

1. Determining the maturity date 2. Computing interest

3 Reasons for the Sale of Receivables

1. Size (financing for large purchases - captive finance companies) 2. 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 3. Billing and collection are often time-consuming and costly - retailers often sell receivables to another party that has expertise in billing/collection matters (e.g. credit card companies)

What are the 2 methods used in accounting for uncollectible accounts?

1. The Direct Write-Off Method 2. The Allowance method

Why do companies sell receivables?

1. They may be the only reasonable source of cash. When money is tight, companies may not be able to borrow money in the usual credit markets. Or if money is available, the cost of borrowing may be prohibitive. 2. Billing and collection are often timeconsuming and costly. It is often easier for a retailer to sell the receivables to another party with expertise in billing and collection matters. Credit card companies such as MasterCard, Visa, and Discover specialize in billing and collecting accounts receivable.

How to record the recovery of bad debt

2 journal entries 1. Reverses the entry made in writing off the account 2. Journalizing the collection in the usual manner 1. A = L + SE +$ -$ Accounts receivable (debit) Allowance for doubtful accounts (credit) 2. A = L + SE +$ -$ ------ Cash Flows +$ Cash (debit) Accounts receivable (credit)

Journal entry for interest earned but not yet received

A = L + SE +$ +$ rev ------- Cash flows no effect Debit Interest Receivable ($ X % X time) Credit Interest Revenue

Journal entry for notes receivable honored w/ interest

A = L + SE +$ -$ +$ --- +$ Debit Cash Credit Notes Receivable (face value) Credit Interest Revenue

Journal entry for a dishonored notes receivable

A = L + SE +$ -$ +$ rev ------ Cash flow no effect Debit Accounts Receivable increase Credit Notes Receivable decrease Credit Interest Revenue increase

Journal entry for note maturity

A = L + SE +$ -$ -$ +$ rev ------- Cash flows +$ Debit Cash increase (face value + interest) Credit Notes Receivable decrease (face value) Credit Interest Receivable decrease (interest accrued) Credit Interest Revenue increase (rest of interest)

Journal entry for note receivable

A = L + SE +$ -$ ---- Cash flows no effect Notes Receivable (debit) Accounts Receivable (credit)

Journal entry for credit card sale

A = L + SE +$ = L + -$ +$ Debit Cash Debit Service Charge Expense Credit Sales Revenue

Journal entry for adjusting allowance account to total estimated uncollectibles

A = L + SE -$ = L + +$ ------ Cash flows no effect (Debit) Bad Debt Expense (Credit) Allowance for Doubtful Accounts

Factor

A finance company or bank that buys receivables from businesses and then collects the payments directly from the customers. A common sale of receivables is a sale to a factor. Typically, the factor charges a commission to the company that is selling the receivables. A retailer's acceptance of a national credit card is another form of selling (factoring) the receivable.

Dishonored (Defaulted) Note

A note that is not paid in full at maturity. A dishonored note receivable is no longer negotiable. However, the payee still has a claim against the maker of the note for both the note and the interest. Therefore, the note holder usually transfers the Notes Receivable account to an Accounts Receivable account.

Which accounts does a write-off affect?

A write-off affects only balance sheet accounts—not income statement accounts. The write-off of the account reduces both Accounts Receivable and Allowance for Doubtful Accounts.

Notes Receivables

A written promise (as evidenced by a formal instrument) for amounts to be received. The note normally requires the collection of interest and extends for time periods of 60-90 days or longer. Notes and accounts receivable that result from sales transactions are often called trade receivables.

Promissory Note

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, or (3) in settlement of accounts receivable. Promissory notes are negotiable instruments (as are checks), which means that they can be transferred to another party by endorsement. Companies frequently accept notes receivable from customers who need to extend the payment of an outstanding account receivable. They often require such notes from high-risk customers.

Accounts Receivables

Amounts customers owe on account. They result from the sale of goods and services. Companies generally expect to collect accounts receivable within 30 to 60 days. They are usually the most significant type of claim held by a company.

Receivables

Amounts due from individuals and companies. Receivables are claims that are expected to be collected in cash. Represents one of a company's most liquid assets

What type of sale is a credit card sale considered?

Cash Sales The retailer must pay to the bank that issues the card a fee for processing the transactions. The retailer records the credit card slips in a similar manner as checks deposited from a cash sale.

Where does Allowance for Doubtful Accounts show on the Balance Sheet?

Current Assets Cash Accounts Receivable Less: Allowance for Doubtful Accounts .... ..... Total current assets

Journal entry to record a write-off

Decreases (debits) Allowance for Doubtful Accounts Decreases (credits) Accounts Receivable

Formula for Computing Interest

Face value of note X Annual Interest Rate X Time in terms of one year = Interest

Amount due at maturity of notes receivable

Face value of the note + interest

Maker

In a promissory note, the party making the promise to pay is called the maker.

Other Receivables

Include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable. These do not generally result from the operations of the business. Therefore, they are generally classified and reported as separate items in the balance sheet

Journal entry for merchandiser selling of goods

Increases (Debits) Accounts Receivable Increases (Credits) Sales Revenue

Journal entry for recording collection of accounts receivable after sales discount

Increases (Debits) Cash (Debits) Sales Discounts Decreases (Credits) Accounts Receivable

Journal entry for return of merchandise

Increases (Debits) Sales Returns & Allowances Decreases (Credits) Accounts Receivable

Journal entry to record estimate of uncollectible accounts

Increases (debits) Bad Debt Expense Increases (credits) Allowance for Doutbful Accounts

How are short-term notes receivable valued?

Like accounts receivable, companies report short-term notes receivable at their cash (net) realizable value. The notes receivable allowance account is Allowance for Doubtful Accounts. The estimations involved in determining cash realizable value and in recording bad debt expense and the related allowance are done similarly to accounts receivable.

Average Collection Period Formula

Measures the average amount of time that a receivable is outstanding. Average Collection Period = 365/Accounts Receivable Turnover Smaller value is better

Where are short-term receivables reported in the balance sheet?

Short-term receivables are reported in the current assets section of the balance sheet, below short-term investments.

Why is determining the amount to report for receivables sometimes difficult?

Some receivables will become uncollectible. E.g. customers not being able to pay. Companies record credit losses as Bad Debt Expense (or Uncollectible Accounts Expense). Such losses are a normal and necessary risk of doing business on a credit basis.

Allowance Method

The allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of each period. This provides better matching of expenses with revenues on the income statement. It also ensures that companies state receivables on the balance sheet at their cash (net) realizable value.

Cash (net) realizable value

The net amount the company expects to receive in cash. It excludes amounts that the company estimates it will not collect. Sometimes referred to as accounts receivable (net)

Accounts Receivable Turnover Formula

The ratio used to assess the liquidity of receivables. This ratio measures the number of times, on average, a company collects receivables during the period. Accounts Receivable Turnover = Net Credit Sales/Average Net Accounts Receivable Larger value is better

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.

Aging the Accounts Receivable

To more accurately estimate the ending balance in the allowance account, a company often prepares a schedule, called aging the accounts receivable. This schedule classifies customer balances by the length of time they have been unpaid. After the company arranges the accounts by age, it determines the expected bad debt losses by applying percentages, based on past experience and other factors, to the totals of each category. The longer a receivable is past due, the less likely it is to be collected. As a result, the estimated percentage of uncollectible debts increases as the number of days past due increases. An aging schedule helps users determine if the amount of past due accounts is increasing and which accounts require management's attention.

Direct Write-Off Method

Under the direct write-off method, when a company determines a particular account to be uncollectible, it charges the loss to Bad Debt Expense. Bad Debt Expense will show only actual losses from uncollectibles. Use of the direct write-off method can reduce the relevance of both the income statement and the balance sheet. Companies often record bad debt expense in a period different from the period in which they record the revenue. The method does not attempt to match bad debt expense to sales revenue in the income statement. Nor does the direct write-off method show accounts receivable in the balance sheet at the amount the company actually expects to receive. Consequently, unless bad debt losses are insignificant, the direct write-off method is not acceptable for financial reporting purposes.

When would a company use the allowance method for financial reporting purposes?

When bad debts are material in amount. The Direct Write-Off Method are only suitable if bad debt losses are insignificant.

What type of receivable is evidenced by a formal instrument and normally requires the payment of interest? a. A note receivable b. An account receivable c. Past-due accounts receivables d. A trade receivable

a. A note receivable A note receivable represent claims for which formal instruments of credit are issued as evidence of the debt. The note normally requires the payment of the principal and interest on a specific date.

Which of the following is the correct sequence to report receivables on the balance sheet? a. Accounts receivable, a 6-month note receivable, other receivables b. Accounts receivable, other receivables, a 6-month note receivable c. A 6-month note receivable, accounts receivable, other receivables d. A 6-month note receivable, other receivables, accounts receivable

a. Accounts receivable, a 6-month note receivable, other receivables Receivables are assets that must be reported in the order of liquidity. Those expected to be converted into cash more quickly are reported first.

Which one of the following statements is true? a. Bad Debts Expense is a nominal account and is closed at the end of the fiscal period, while Allowance for Doubtful Accounts is a real account and remains open at the end of the fiscal period. b. Bad Debts Expense and Allowance for Doubtful Accounts are both nominal accounts and are closed at the end of the fiscal period. c. Bad Debts Expense and Allowance for Doubtful Accounts are both real accounts and neither are closed at the end of the fiscal period. d. Bad Debts Expense is a real account and remains open at the end of the fiscal period, while Allowance for Doubtful Accounts is a nominal account and is closed at the end of the fiscal period.

a. Bad Debts Expense is a nominal account and is closed at the end of the fiscal period, while Allowance for Doubtful Accounts is a real account and remains open at the end of the fiscal period.

At what amount is a short-term notes receivable recorded on the issue date? a. Face value b. Maturity value c. Present value d. Fair market value

a. Face value Short-term notes receivable are recorded at face value, which is the principal amount of the note.

Which one of the following is not one of the five basic issues in accounting for notes receivable? a. Realizing notes receivable b. Valuing notes receivable c. Recognizing notes receivable d. Disposing of notes receivable

a. Realizing notes receivable The five basic issues in accounting for notes receivable are 1) determining the maturity date, 2) computing interest, 3) recognizing notes receivable, 4) valuing notes receivable, and 5) disposing of notes receivable.

Factoring is the process of a. selling accounts receivable at a discount to another party. b. determining the allowance for doubtful accounts value. c. determining the percentage of accounts receivable expected to be collected. d. determining the average collection period.

a. selling accounts receivable at a discount to another party.

Which statement is true about reporting receivables on the balance sheet? a. Bad Debts Expense and Allowance for Doubtful Accounts are shown as a deduction from Accounts Receivable on the balance sheet. b. Allowance for Doubtful Accounts is shown as a deduction from Accounts Receivable on the balance sheet. c. Bad Debts Expense is is shown as a deduction from Accounts Receivable on the balance sheet. d. Bad Debts Expense is subtracted from Accounts Receivable and is then shown as a deduction from Accounts Receivable on the balance sheet.

b. Allowance for Doubtful Accounts is shown as a deduction from Accounts Receivable on the balance sheet. Allowance for Doubtful Accounts is a contra asset account that is shown as a deduction from Accounts Receivable on the balance sheet in the current asset section.

At what value are accounts receivable reported on the balance sheet? a. Maturity value b. Cash (net) realizable value c. Present value d. Fair market value

b. Cash (net) realizable value Accounts receivable are reported at net realizable value. This value is the total amount due less an estimate for doubtful accounts.

What is often the most critical part of managing receivables? a. Determining which method to use to account for bad debts b. Establishing a payment period c. Determining who gets credit and who doesn't d. Monitoring the receivables

c. Determining who gets credit and who doesn't

Which of these statements about Visa credit card sales is incorrect? a. The retailer is not involved in the collection process. b. The retailer receives cash more quickly than it would from individual customers. c. The retailer must wait to receive payment from the issuer. d. The credit card issuer conducts the credit investigation of the customer.

c. The retailer must wait to receive payment from the issuer. There is no wait for payment. The retailer receives payment at the time the credit card is accepted from the customer.

What type of receivables result from sales transactions? a. Other receivables b. Non-trade receivables c. Trade receivables d. Long-term receivables

c. Trade receivables Accounts receivable and notes receivable resulting from sales transactions are called trade receivables.

Which of the following is a threat of nonpayment from a single customer or class of customers that could adversely affect the financial health of a company? a. Payment risk b. Concentration risk c. Credit risk d. A concentration of credit risk

d. A concentration of credit risk A threat of nonpayment from a single customer or class of customers that could adversely affect the financial health of a company is called a concentration of credit risk.

Which one of these statements about promissory notes is incorrect? a. The party making the promise to pay is called the maker. b. A promissory note is more liquid than an account receivable. c. The party to whom payment is to be made is called the payee. d. A promissory note is not a negotiable instrument.

d. A promissory note is not a negotiable instrument. Promissory notes are negotiable instruments, meaning if sold, the seller can transfer to another party by endorsement.

On the date a 90-day note is honored, how much cash will the payee receive? a. Face value b. Maturity value plus 90 days of interest c. Maturity value less the face value d. Face value plus 90 days of interest

d. Face value plus 90 days of interest

If a company is concerned about lending money to a risky customer, which one of the following would it not want to do? a. Require the customer to provide a letter of credit or a bank guarantee. b. Require the customer to pay cash in advance. c. Contact references provided by the customer, such as banks and other suppliers. d. Provide the customer a lengthy payment period to increase the chance of paying.

d. Provide the customer a lengthy payment period to increase the chance of paying. Longer payment period will increase the chances the company will not pay. Companies might require risky customers to provide letters of credit or bank guarantees, require them to pay cash in advance, or ask for references from banks and suppliers to determine their payment history.

Which one of the following is not a method used by companies to accelerate cash receipts? a. Offering discounts for early payment b. Accepting national credit cards for customer purchases c. Selling receivables to a factor d. Writing off receivables

d. Writing off receivables

Notes receivable are reported in the current assets section of the balance sheet at a. market value. b. total principal plus interest for the term of the loan. c. the selling price at which the inventory was sold to the customers. d. cash (net) realizable value.

d. cash (net) realizable value. Companies report accounts receivable, notes receivable, and other receivables in the current asset section of the balance sheet at their expected cash (net) realizable value.

What factors affect the relative significance of a company's receivables as a percentage of its assets?

its industry, the time of year, whether it extends long-term financing, and its credit policies