BUS Chapter 8

Steps to managing account receivables

1. Determine to whom to extend credit. 2.Establish a payment period. 3. Monitor collections. 4. Evaluate the liquidity of receivables. 5. Accelerate cash receipts from receivables when necessary.

3 parties involved when national credit cards are used in making retail sales

(1) the credit card issuer, who is independent of the retailer (2) the retailer (3) the customer. A retailer's acceptance of a national credit card is another form of selling—factoring—the receivable by the retailer.

Factor

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

Honor of notes receivable

A note is honored when its maker pays in full at its maturity date. For each interest-bearing note, the amount due at maturity is the face value of the note plus interest for the length of time specified on the note.

Note receivable

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.

Account receivable

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.

Computing Interest

Face value of note * Annual Interest rate * Time in terms of one year = Interest

Other receivable

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 in the balance shee

Maturity date

May be stated in one of three ways: (1) on demand, (2) on a stated date, and (3) at the end of a stated period of time. When it is stated to be at the end of a period of time, the parties to the note will need to determine the maturity date.

Average Collection Period

Measures the average amount of time that a receivable is outstanding. This is done by dividing the accounts receivable turnover into 365 days.

Cash (net) realizable value

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

A dishonored (defaulted) note

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. If the lender expects that it eventually will be able to collect, the two parties negotiate new terms to make it easier for the borrower to repay the debt. If there is no hope of collection, the payee should write off the face value of the note.

Determining the maturity date

Of a three-month note dated May 1 would be August 1. A note drawn on the last day of a month matures on the last day of a subsequent month. That is, a July 31 note due in two months matures on September 30. When the due date is stated in terms of days, you need to count the exact number of days to determine the maturity date. Omit the date the note is issued but include the due date.

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. It also ensures that receivables are stated at their cash (net) realizable value on the balance sheet. Under the allowance method, a company debits every bad debt write-off to the allowance account and not to Bad Debt Expense.

Bad Debt Expense

The seller records losses that result from extending credit as Bad Debt Expense. Such losses are a normal and necessary risk of doing business on a credit basis. Two methods are used in accounting for uncollectible accounts: (1) the direct write-off method and (2) the allowance method.

Receivables

The term receivables refers to amounts due from individuals and companies. Receivables are claims that are expected to be collected in cash. The management of receivables is a very important activity for any company that sells goods or services on credit. Receivables are important because they represent one of a company's most liquid assets.

Accounts Receivable Turnover ratio

Used to assess the liquidity of receivables, computed by dividing net credit sales (net sales less cash sales) by the average net accounts receivable during the year. This ratio measures the number of times, on average, a company collects receivables during the period.

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. The direct write-off method is not acceptable for financial reporting purposes.

Promissory note

Written promise to pay a specified amount of money on demand or at a definite time. 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, and (3) in settlement of accounts receivable The party making the promise to pay is called the maker. The party to whom payment is to be made is called the payee.