Accounting Chapter 8: Reporting and Analyzing Receivables

Notes Recievable

A promisory note s a written primuse to pay a specified amount of money on demand or at a definite time. They may be used when companies or individuals lend or borrow money, when the amount of the transaction and the credit period exceed normal limits and in settlement of accounts receivable. In this note the party making the promise to pay is called the maker and the party to whom payment is to be made is called the payee. Notes receivable give the holder a strong legal claim to assets than do accounts reciavble. They can be readily sold and are negotiable instrurments. Companies frequently accept notes recievable from customers who need to extned the payment of an outstanding account receivable. Companies also oftern require notes from high risk customers. You must determine the maturity date, compute the interest, recognize the notes recievable, value the notes receivable and sipose of the notes recieveable.

Recognizing Accounts Receivable

A service organization records a receivable when it preforms a service on account. A merchandiser records accounts receivable at the point of sale of merchandise on account. When a merchandiser sells goods, it increases (debits) accounts receivable and increases (credits) sales revenue.

Notes Recievable

A written promise as evidenced bya formal instrument for amounts to be recieved. 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.

Accounts recievable

Amounts customers owe on account. they result from the sale of goods and services, normally expect to collect within 30-60 days, the most significant type of claim held by a company.

Receivables

Amounts due from individuals and companies, claims that are expected to be collected in cash. Receivables are important because they represent one of a company's most liquid assets. The relative significance of a company's receivables depends on various factors: its industry, the time of year, whether it extends long term financing and its credit policies.

Percentage of Receivables Basis

Management establishes a percentage relationship between the amount of receievables and expected losses from uncollectible accounts.

Computing Interest

interest=face value of note*annual interest rate*time in terms of one year. The interest rate is an annual rate of interest.

Three features of allowance method

Companies must use the allowance method for financial reporting purposes when bad debts are material in amount. It has three essential features: 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 collectibles to allowance for doubtful accounts and credit them to accounts receivable at the time the specific account is written off as uncollectable.

Valuing Accounts Receivable

Companies report accounts receivable on the balance sheet as an asset, determining the amount to report is sometimes difficult because some receivables will be uncollectible. Although each customer must satisfy the credit requirements of the seller before the credit sale is approved, inevitably some accounts receivable become uncollectible. For example, a corporate customer may not be able to pay because it experienced a sales decline due to an economic downturn. Similarly, individuals may be laid off of their jobs. The seller records these losses that result from extending credit as bad debt expense.Such losses are necessary and normal risk of doing business on a credit basis.

Valuing Notes Receivable

Companies report short term notes recievable at their cash net realizable value. This is the allowance for doubtful accounts.

Other Receivables

Include non trade 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 on the balance sheet.

Recovery of an Uncollectible Account

Occasionally a company collects from a cystomer after the account has already been written off as uncollectible. The compnay must make two entries to record the recovery of bad debt (1) it reverses the entry made in writing off the account. This reinstates the customers account. (2) it journalizes the collection in the usual manner. The recovery of bad debt like its write off only affects balance sheet accounts.The net effect of the two entries is an increase in cash and an increase in allowance for doubtful accounts.

Debit Balance

Occasionally the allowance account will have a debit balance prior to adjusting because the debits to allowance account from wite offs during the year exceeded the beginning balance in the account which was based on previous estimates for bad debts. In such case the company adds the debit balance to the required balance when it makes the adjusting entry.

Recording Estimated Uncollectibles

The adjusting entry to record the estimated collectibles increases (debits) bad debt expense and increases (credits) allowance for doubtful accounts. COmpanies report bad debt expense in the income statment as an operating expense(usually a selling expense), thus it matches the estimated uncollectables with sales in 2014 because the expense is recorded in the same year the company makes the sales. The allowance for doubtful accounts shows the estimated amounts of claims on customers that companies will expect to be uncollectible in the future. Companies use a contra account instead of direct credit to accounts receivable because they do not know which customers will not pay. The credit balance in the allowance account will absorb the specific write offs that will occur when they occur. The company deducts the allowance account from accounts receivable in the current assets section of the blance shet. Companies do not close allowance for doubtful accounts at the end of the fiscal year.

Allowance Method for Uncollectible Accounts

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 and also ensures that receivables are stated at their cash (net) realizable value on the balance sheet.

Recognizing Notes Receivable

The company records the note recievable at its face value, the vale shown on the face of the note. No interest revenue is reported when the company accepts the note because the revenue recogintion priniciple does not recognize revenue until the performance obligation is satified. If a company issues cash in exchnage for a note, the entry is debit notes recievable and credit to cash in the amount of the loan.

Determining Maturity Date

The maturity date on a promisory note may be stated in one of three ways: on demand, on a stated date, and at the end of a stated period of time. When the life of the note is expressed in terms of months, you find the date when it matures by counting down the months from the date of issue. When the 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.

Cash net realizable value

The net amount a company expects to receive in cash from reciebables. It excludes amounts that the company estimates it will not collect. Estimated uncollectible receivables therefore reduce receivables on the balance sheet through the use of the allowance method.

Amount of Bad Debt Expense

The total estimated uncollectible accounts represent the existing customer claims expected to be uncollected in the fuute. This amount represents the required balance in allowance for doubtful accounts at the balance sheet date. Accordingly, the amount of bad debt epense that should be recorded in the adjusting entry is the difference between the required balance and the existing balance in the allowance account. The existing adjusted balance in the allowance for doubtful accounts is the net result of the beginning balance (a normal credit balance) less the write offs of specific accounts during the year (debits to the allowance account).

Aging the Accounts Receivab;le

To more accurately estimate the ending balance in the allowance account, this schedule is proposed that classifies customer balances by the length of time they have been unpaid.The longer a recievable is past due, the less likely it is to be collected.As a resilt, the estimated percetage of uncollected debts increases as the number of days past due increases.

Recording the Write Off of an uncollectible Account

Various methods are used to collect past due accounts. When a company exausts all means of collecting a past due account and collection appears unlikely, the companies wrties off the account. In the credit card industry, the standard practice is to write off accounts that are 210 days past due. To prevent premature or unauthorized write offs, authorized management personell should formally approve each write off. To maintain segregation of duties, the employee authorized to write off accounts should have daily responsibilities related to cash or recievables. The company does not increase bad debt expense when the write off occurs, under the allowance method, a company debits every bad debt write off to the allowance account and not to bad debt expense. Instead, the entry to record the write off of an uncollectible account reduces both accounts receivable and allowance for doubtful accounts. A write off affects only balance sheet accounts. Cash realizable value in teh balance sheet remains the same before and after the write off.

Direct Write off Method for Uncollectible Accounts

When a company determines receivables from a particular company to be uncollectible, it charges the loss to bad debt expense. Under this method, bad debt expense will show only actual losses from uncollectibles. The company reports accounts receivab,e at its gross amount without any adjustment for estimated loss for bad debts. Use of the direct write off method can reduce the usefulness of both the income statement and balance sheet. Under this method, companies often record bad debt expense ina period different from the period in which they recorded the revenue. Thus, no attempt is made to match bad debt expense to sales revenues in the income statement, nor does the company try to show accounts receivable in the balance sheet at the amount actually expected to be received. Unless a company expects bad debt losses to be insignificant, the direct write off method is not acceptable for financial reporting purposes.