ACCT 100 Chapter 8 Accounting for Receivables Short-Term Investments & Receivables2 Chapter...

ACCT 100

Chapter 8

Accounting for Receivables

Short-Term Investments & Receivables 2

Chapter Objectives

1. Accounts Receivables and Notes Receivables

2. Using Accounting for Decision Making


Accounts Receivable and Notes Receivable

Receivables: monetary claims against business or individuals from selling goods, providing services or lending money (i.e., accounts receivable, notes receivable, interest receivable).


A. Accounts Receivable (A/R) (trade receivables): An oral promise for future cash receipt as a result of sales; a current asset.

The accounts receivable account in the general ledger serves as a control account which records the total amounts of receivable from all customers. Companies also keep subsidiary ledger accounts receivable for each customer.


A. Accounts Receivable (Continued)

General Ledger

A/RBal. 10,000

Subsidiary LedgerA/R

A. CompanyBal. 3,000

B. CompanyBal. 4,000

C. CompanyBal. 3,000

Total $10,000

Journal Entries:

A/R - A Company 3000Sales Revenue 3000

A/R - B Company 4000Sales Revenue 4000

A/R - C Company 3000Sales Revenue 3000


Uncollectible Accounts (Bad Debts)

The benefit of allowing customers to purchase on credit (or on account) is the increase of sales.

The risk associates with this practice is the cost of uncollectible accounts.


The Accounting for the Uncollectible Accounts (Bad Debt (B/D) Expense):

Current Practice: Estimate the B/D expense at the end of the period and recognize the expense (FASB No.5)

Adjusting entry for B/D expense:Estimated B/D expense = $2,00012/31 B/D Exp. (or Uncollectible Accounts Expense) 2000

Allowance for Uncollectible Accounts 2000

Writing off uncollectible accounts:When $200 B/D actually occurred:Allowance for uncollectible Accounts 200

A/R - A Company 200


The Accounting for the Uncollectible Accounts (Continued)

If $100 of the B/D recovered:A/R 100

Allowance for Uncollectible Accounts 100Cash 100

A/R 100

The current practice is complied with the matching principle.

The direct write-off method (recognize the B/D expense when it occurs) is NOT recommended.


Estimation of B/D Expense:

1. Percentage of net credit sales (I/S approach)

2. Percentage of accounts receivable (B/S approach)

3. Aging of accounts receivable (B/S approach using individual account information)


Estimation of B/D Expense Example:

1. Net credit sales = $20,000

Estimated B/D expense = 2%

12/31 B/D Expense 400

Allowance for uncollectible accounts 400


Estimation of B/D Expense Example: (Continued)2. Percentage of A/R:

A/R Balance = $50,000Estimated B/D expense = 1%Balance of the Allowance for uncollectible

accounts prior to the adjustment= $300The adjusted balance of the allowance for

uncollectible accounts = $50,000 * 1% = $500Bad Debt Expense = $500 - 300 = 200

B/D expense 200Allowance for uncollectible accounts

200


Estimation of B/D Expense Example: (Continued)3. Aging-of-A/R: The balance of the allowance

account prior to adjustment= $100

B/D expense = $440 - 100 = 34012/31 adjusting entry:B/D Expense 340

Allowance for uncollectible accounts 340

Age Amount B/D(%) Allowance Amount0-30 $10,000 1 $100

31-60 $7,000 2 $14061-90 $4,000 3 $120

over 90 $2,000 4 $80Total $440


Estimation of B/D Expense

All three estimation methods are acceptable for the financial reports. In practice, some companies use the percentage of sales method for the interim statements (i.e., monthly or quarterly reports), but use the aging of accounts receivable method for the annual financial reports.


Credit-Card Sales

Benefits of credit-card sales to

a. Customers: the convenience of purchase and payment.

b. Companies (the sellers):

1)no risk of uncollectible accounts;

2)no need to do a credit check;


Credit-Card Sales (Continued)

3) increase of sales;

4) receive cash quickly.

c. Credit-Card Companies: charge 2% to 6% of service charge to the seller (source: Weygandt, etc. textbook).

Disadvantages of credit-card sales to customers, companies (the sellers) and the credit-card companies:


Accounting for Credit Card Sales – Credit Cards Issued by a Financial Company: Example: Suppose you shopped at the Gap and

paid $100 for a sweater using a VISA card. Gap’s entry to record the VISA card sale, subject to 2% VISA discount (the service charge by VISA):

Cash 98

Service Charge Expense 2

Sales Revenue 100


B. Accounting for Notes Receivable For an example of a promissory note,

see Illustration 8-10 of Weygandt, etc. textbook.

N/R: a written promissory note that the debtor (the maker of the note) promises to pay the creditor (the payee) the written amount on a specific date plus the agreeable interest.


B. Accounting for Notes Receivable (Continued)

Short-Term N/R: the note is due within one year or one operating cycle, whichever is longer. Short-term N/R is recorded at the amount expected to be collected.

Long-Term N/R: the due date of the note is beyond one year or one operating cycle, whichever is longer.

For interest bearing N/R, the accrued interest is recognized at the end of period.


Example (a):

a. Greenway Co. signed a promissory note to borrow $1,000 from Kay Bank on 9/30/08. The note is an interest bearing note with an annual interest rate of 12%. The maturity of the note is on 3/31/09 (i.e., a six-month note).

Kay Bank’s entries are as follows:

9/30/08 Note Receivable -- Greenway 1,000Cash 1,000


Example (a): (Continued)

12/31/08 Interest Receivable 30

Interest Revenue 30

3/31/09 Cash 1,060

Note Receivable -- Greenway 1,000

Interest Receivable 30

Interest Revenue 30

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Example (b):

b. On 4/16/08, Gateway Co. receives a $12,000 90-day promissory note at 12% annual interest from a customer (Four Seasons) from selling personal computers. Gateway’s entries to record the sale and collection are:

4/16/08 N/R -- Four Seasons 12,000Sales Revenue 12,000

7/15/08 Cash 12,360N/R 12,000Interest Revenue 360

Interest = $12,000x12% x 90/360 = $360

Dishonored Note

If Four Season (the maker) failed to pay Gateway (the payee) on 7/15/08, Gateway will make the following entry:

Accounts Receivable 12,360

Note Receivable 12,000

Interest Revenue 360



Example (c):

c. On 5/2/08, Grouti Co. sees that it will not be able to pay off its $5,000 account payable to GE Co. Grouti negotiated with GE. GE accepts a one-year $5,000 promissory note, with 10% interest from Grouti on 5/17/08 to settle Grouti’s $5,000 account receivable. GE’s entry is:

Note Receivable -- Grouti Co. 5,000Accounts Receivable -- Grouti Co. 5,000


Using Receivables to Finance Operations

1. Discounting Notes Receivables (with contingent liabilities).

2. Factoring Accounts Receivables


Internal Control Issue of Receivables

Separation of bookkeeping of receivable accounts from receiving of cash payments


Using Accounting for Decision Making

Current ratio = Current Assets

Current Liabilities

Short-Term Net CurrentAcid-Test (Quick) ratio = Cash + Investment + Receivables

Current Liabilities

In general, a quick ratio of 1 is considered to be safe.

Average Collection Period

Accounts receivable turnover rate =

Net credit sales (annual) /average net A/R

Average collection period =

365 days / Accounts rece. turnover rate


Average Collection Period (contd.)

Example: Net Credit Sales (annual)= $912,500 Average A/R = $60,000 Accounts receivable turnover rate=$912,000/$60,000 = 15.2 (times) Average Collection Period of A/R =365 days/15.2 = 24 days


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