Receivables

Chapter 9

Accounts receivable

Receivables

Notes receivable

Design internal controls

for receivables.

Objective 1

Establishing Internal Control

What are some controls over accounts receivable?

Separationof duties

Approval for write-off

Control overmail receipts

Use the allowance methodto account for uncollectibles

and estimate uncollectiblesby the percent of salesand aging approaches.

Objective 2

The Credit Department

Companies grant credit to customers in order to increase sales.

The credit department evaluates customers who apply for credit cards.

Uncollectible Accounts Expense

Allowance method

Direct write-off method

Methods for Estimating Uncollectible Expense

Percentage of Sales

Aging of Receivables

Percentage of Sales

This is also called the income statement approach.

It is based on prior experience of the business. It is computed as a percentage of credit sales. It ignores the current balance of the allowance

account. The percentage used is adjusted as needed to

reflect collection experience.

Percentage of Sales Example

The credit department of Ana’s Boutique estimates (based on prior experience) that 1% of net credit sales are uncollectible.

Net credit sales for the year just ended were $500,000.

What is the adjusting entry? $500,000 × 1% = $5,000

Percentage of Sales Example

Dec 31, 20xxUncollectible Account Expense 5,000

Allowance for Uncollectible Accounts 5,000

Recorded expense for the year

Decrease inNet Income

Decrease in netAccounts Receivable

What is the effect of this adjusting entry?

Percentage of Sales Example

Aging of Accounts Receivable

This approach is also called the balance sheet approach because it focuses on accounts receivable.

Individual accounts receivable from specific customers are analyzed according to the length of time they remain outstanding.

Aging of Receivables Example

Assume that International Hospital’s past collection experience indicates the following:

Length of time % uncollectible 1-30 days 2.0 31-60 days 3.0 61-90 days 5.0 90 + days 8.0

AccountsReceivable

Allowance forUncollectible Accounts

Length Amount %1-30 $1,900,000 2 $ 38,00031-60 1,000,000 3 30,00061-90 700,000 5 35,00090 + 500,000 8 40,000Total $4,100,000

$143,000

Aging of Receivables Example

Aging of Receivables Example

The allowance account is adjusted to this $143,000 balance:

Assume that the account currently has a credit balance of $100,000.

What is the adjustment?

Uncollectible Account Expense 43,000

Allowance for Uncollectible Accounts 43,000

To record allowance for uncollectibles

What if the account had adebit balance of $1,000?

Aging of Receivables

Allowance for UncollectibleAdjustment

1,000 144,000Adjusted balance 143,000

Aging of Receivables

Comparing the Percentage of Sales and Aging Methods

Allowance Method

Percent of Sales Method Aging of Accounts Receivable Method

Adjusts Allowance forUncollectible Accounts

Adjusts Allowance forUncollectible Accounts

BY TO

UNCOLLECTIBLEACCOUNT EXPENSE

UNCOLLECTIBLEACCOUNTS RECEIVABLE

Amount of Amount of

Writing OffUncollectible Accounts What happens when it becomes apparent

that an account will not be collected? It must be written off. How? Debit Allowance for Uncollectible

Accounts. Credit Accounts Receivable.

Recoveries

How is the collection of a previously written- off account recorded?

Debit Accounts Receivable (to reinstate the account).

Credit Allowance for Uncollectible Accounts. Debit Cash. Credit Accounts Receivable (to record the

collection).

Use the direct write-off method

to account for uncollectibles.

Objective 3

Direct Write-Off Method

Using this method, an account is written off only when it becomes uncollectible.

No allowance account is created. This method is simple to use. The balance sheet is overstated. The income statement is understated.

Credit Card and Bankcard Sales

These save retailers the cost of a credit department.

The retailer is required to pay a fee (called a discount) for usage.

Credit Card and Bankcard Sales

How would Ana’s Boutique record a $100 credit card sale with a 2% service charge?

Accounts Receivable (credit card) 98Credit Card Discount 2

Sales Revenue 100To record a credit card sale of $100less a 2% service charge fee

Debit Card Sales

Using a debit card is likepaying with cash.

Notes Receivable: an Overview

A note receivable may arise from a sale or may be given in settlement of an account receivable.

The maker pays the payee the maturity value.

The maturity value includes principal plus interest.

Promissory Note $10,000.00 Nov. 30, 2004

For value received, I promise to pay to the order of

POPULAR BANK

HOUSTON, TEXAS

TEN THOUSAND AND NO/100…………DOLLARS

ON FEBRUARY 28, 2005

Plus interest at the annual rate of 10 percent.

__________Payee

Notes Receivable: an Overview

Promissory Note $10,000.00 Nov. 30, 20x4

For value received, I promise to pay to the order of

POPULAR BANK

HOUSTON, TEXAS

TEN THOUSAND AND NO/100…………DOLLARS

ON FEBRUARY 28, 20x5

Plus interest at the annual rate of 10 percent.

__________Principal

Notes Receivable: an Overview

Promissory Note $10,000.00 Nov. 30, 20x4

For value received, I promise to pay to the order of

POPULAR BANK

HOUSTON, TEXAS

TEN THOUSAND AND NO/100…………DOLLARS

ON FEBRUARY 28, 20x5

Plus interest at the annual rate of 10 percent.

__________

Date of issue

Notes Receivable: an Overview

Interest rate

Promissory Note $10,000.00 Nov. 30, 20x4

For value received, I promise to pay to the order of

POPULAR BANK

HOUSTON, TEXAS

TEN THOUSAND AND NO/100…………DOLLARS

ON FEBRUARY 28, 20x5

Plus interest at the annual rate of 10 percent.

__________

Notes Receivable: an Overview

Maturity date

Identifying a Note’sMaturity Date When the period is given in days…– the maturity date is determined by counting

the days from the date of issue. The date the note was issued is omitted. The maturity date is counted.

Principal × Rate × Time = Interest

$10,000 × 10% × 90 ÷ 360 = $250

Computing Interest on a Note

Compute interest on the note due to Popular Bank.Principal: $10,000Interest: 10%Time: December 1, 20x4, to February 28, 20x5

Account for notes receivable.

Objective 4

Recording Notes Receivable

Assume the accounting period ended December 31.

How much interest was earned by the bank as of December 31?

$10,000 × 10% × (31 ÷ 360) = $86.11

Recording Notes Receivable

December 31Interest Receivable 86.11

Interest Revenue 86.11To accrue interest on the note

Recording Notes Receivable

How does the bank record the collection at maturity?

February 28Cash 10,250.00

Note Receivable 10,000.00Interest Receivable 86.11Interest Revenue 163.89

Record interest on note

Dishonored Notes Receivable

If the maker of the note fails to pay the maturity value to the new payee, then the original payee legally must pay the bank the amount due.

Report receivableson the balance

sheet.

Objective 5

Reporting Receivables

Some companies report a single amount for its current receivables in the body of the balance sheet.

They use a note to the financial statements to give more details.

Use the acid-test ratio and days’

sales in receivables to evaluatea company.

Objective 6

Acid-test ratio = (Cash + Short-term investments+ Net current receivables) ÷ Total current liabilities

Acid-Test Ratio

This is a stringent test of liquidity. It measures the entity’s ability to pay its

current liabilities immediately.

Days’ Sales in Receivables

It is a measure of the time it takes to collect receivables.

A smaller number indicates a quick conversion to cash.

One day’s sales = Net sales ÷ 365 days

Days’ sales in average accounts receivable =Average net accounts receivable ÷ One day’s sales

Days’ Sales in Receivables

End of Chapter 9