Chapter 05 lecture

Chapter 05

Receivables and Sales

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Part A

Recognition of Accounts Receivable

5-2

Credit sales

o Common for large business transactions in which buyers don’t have sufficient cash available or where credit cards cannot be used because the transaction amount exceeds typical credit card limits.

o Revenue is recognized at the time of a credit sale.

o An asset (accounts receivable) is recognized at the time of a credit sale.

o Common for large business transactions in which buyers don’t have sufficient cash available or where credit cards cannot be used because the transaction amount exceeds typical credit card limits.

o Revenue is recognized at the time of a credit sale.

o An asset (accounts receivable) is recognized at the time of a credit sale.

5-3

LO1 Recognize Accounts Receivable

o Credit sales transfer products and services to a customer today while bearing the risk of collecting payment from that customer in the future.

o Even though the seller does not receive cash at the time of the credit sale, the firm records revenue immediately, as long as future collection from the customer is reasonably certain.

o Along with the recognized revenue, at the time of sale the seller also obtains a legal right to receive cash from the buyer. The legal right to receive cash is valuable and represents an asset of the company.

o Credit sales transfer products and services to a customer today while bearing the risk of collecting payment from that customer in the future.

o Even though the seller does not receive cash at the time of the credit sale, the firm records revenue immediately, as long as future collection from the customer is reasonably certain.

o Along with the recognized revenue, at the time of sale the seller also obtains a legal right to receive cash from the buyer. The legal right to receive cash is valuable and represents an asset of the company.

5-4

Recording of Credit Sales

Link’s Dental charges $500 for teeth whitening. Dee Kay decides to take advantage of the service, has her teeth whitened on March 1, but doesn’t pay cash at the time of service. Dee promises to pay the $500 whitening fee to Link by March 31. Link’s Dental makes the following entry at the time of the whitening.

Link’s Dental charges $500 for teeth whitening. Dee Kay decides to take advantage of the service, has her teeth whitened on March 1, but doesn’t pay cash at the time of service. Dee promises to pay the $500 whitening fee to Link by March 31. Link’s Dental makes the following entry at the time of the whitening.

March 1 Debit Credit500

Service Revenue . . . . . . . . 500Accounts Receivable . . . . . . . . . . . . .

(Provide services on account)

5-5

Other types of receivables

5-6

LO2 Calculate net revenues using discounts, returns, and allowances

o Represents a reduction, not in the selling price of a product or service, but in the amount to be paid by a credit customer if payment is made within a specified period of time.

o It’s a discount intended to provide incentive for quick payment.

o The amount of the discount and the time period within which it’s available usually are communicated in short-hand terms such as 2/10, n/30.o The term “2/10,” indicates the customer will receive a 2%

discount if the amount owed is paid within 10 days.o The term “n/30,” means that if the customer does not take

the discount, full payment is due within 30 days.

o Represents a reduction, not in the selling price of a product or service, but in the amount to be paid by a credit customer if payment is made within a specified period of time.

o It’s a discount intended to provide incentive for quick payment.

o The amount of the discount and the time period within which it’s available usually are communicated in short-hand terms such as 2/10, n/30.o The term “2/10,” indicates the customer will receive a 2%

discount if the amount owed is paid within 10 days.o The term “n/30,” means that if the customer does not take

the discount, full payment is due within 30 days.

Sales Discount

5-7

Trade Discounts

o Represent a reduction in the listed price of a product or service.

o Companies don’t recognize trade discounts directly when recording a transaction. Instead, they recognize trade discounts indirectly by recording the sale at the discounted price.

o Let’s go back to Link’s Dental, which typically charges $500 for teeth whitening. Dr. Link offers a 20% discount on teeth whitening to any of his regular patients.

o Represent a reduction in the listed price of a product or service.

o Companies don’t recognize trade discounts directly when recording a transaction. Instead, they recognize trade discounts indirectly by recording the sale at the discounted price.

o Let’s go back to Link’s Dental, which typically charges $500 for teeth whitening. Dr. Link offers a 20% discount on teeth whitening to any of his regular patients.

Debit Credit400

Service revenue . . . . . . . . . . . . 400 (Make Credit sale of 500 with a 20% trade discount)

Accounts Receivable . . . . . . . . . . .March 1

5-8

First scenario, assume Dee pays on March 10th, which is within the 10-day discount period


8Accounts Receivable 400(Collect cash on account with a 2% sales discount)

Assets = Liabilities +Common

Stock +Retained Earnings Revenues − Expenses =

Net Income

+392 = -8 -8 = -8-400

-8

Balance Sheet Income StatementStockholders’ Equity

Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5-9

First scenario, assume Dee pays on March 10th, which is within the 10-day discount period

Service Revenues $400 Less: Sales discounts (8)

Net Service Revenues $392

Income Statement (partial)LINK’S DENTAL

Credit sale Mar. 1 400 Collection of $392

Mar. 10 400 on account

Ending balance Bal. 0

Accounts Receivable

5-10

Second scenario, assume that Dee waits until March 31 to pay, which is not within the 10-day discount period

Link’s Dental records the following entry at the time he collects cash from Dee.

Link’s Dental records the following entry at the time he collects cash from Dee.

Notice that there is no indication in recording the transaction that the customer does not take the sales discount. This is the typical entry to record a cash collection on account when no sales discounts are involved.

Notice that there is no indication in recording the transaction that the customer does not take the sales discount. This is the typical entry to record a cash collection on account when no sales discounts are involved.

Debit Credit400

Accounts Receivable . . . . 400Cash . . . . . . . . . . . . . . . . . . . . . .

(Cash collection on account )

March 31

5-11

Sales Return and Allowances

Sales Allowances

If a customer does not return a product, but the seller reduces the customer’s balance owed or provides at least a partial refund because of some deficiency in the company’s product or service, we call that a sales allowance

Sales Allowances

If a customer does not return a product, but the seller reduces the customer’s balance owed or provides at least a partial refund because of some deficiency in the company’s product or service, we call that a sales allowance

Sales Return

If a customer returns a product it is sales return. After a sales return,

o we reduce the customer’s account balance if the sale was on account or

o we issue a cash refund if the sale was for cash.

Sales Return

If a customer returns a product it is sales return. After a sales return,

o we reduce the customer’s account balance if the sale was on account or

o we issue a cash refund if the sale was for cash.

5-12

Sales Return and Allowances

On March 5, after Dee gets her teeth cleaned but before she pays, she notices that another local dentist is offering the same procedure for $350. Dee brings this to Dr. Link’s attention and because his policy is to match any competitor’s pricing, he offers to reduce Dee’s account balance by $50.Link’s Dental records the following sales allowance entry.

On March 5, after Dee gets her teeth cleaned but before she pays, she notices that another local dentist is offering the same procedure for $350. Dee brings this to Dr. Link’s attention and because his policy is to match any competitor’s pricing, he offers to reduce Dee’s account balance by $50.Link’s Dental records the following sales allowance entry.


Accounts Receivable 50( Make sales allowance for credit sales)



Net Income

-50 = -50 -50 = -50

Stockholders’ Equity

Sales Allowance

Balance Sheet Income Statement

5-13

Part B

Valuation of Accounts Receivable

5-14

LO3 Record an allowance for future uncollectible accounts

o The right to receive cash from a customer is a valuable resource for the company. This is why accounts receivable is an asset, reported in the company’s balance sheet.

o To be useful to decision makers, accounts receivable should be reported at the amount of cash the firm expects to collect, an amount known as net realizable value.

o The right to receive cash from a customer is a valuable resource for the company. This is why accounts receivable is an asset, reported in the company’s balance sheet.

o To be useful to decision makers, accounts receivable should be reported at the amount of cash the firm expects to collect, an amount known as net realizable value.

5-15

Allowance Method

Involves allowing for the possibility that some accounts will be uncollectible at some point in future.

Uncollectible accounts have the effect of:o reducing assets (accounts receivable) by an estimate of the

amount we don’t expect to collect and o increasing expenses (bad debt expense) to reflect the cost

of offering credit to customers.

Involves allowing for the possibility that some accounts will be uncollectible at some point in future.

Uncollectible accounts have the effect of:o reducing assets (accounts receivable) by an estimate of the

amount we don’t expect to collect and o increasing expenses (bad debt expense) to reflect the cost

of offering credit to customers.



Net Income

= =


5-16

Estimating Uncollectible Accounts

Kimzey specializes in emergency outpatient care. It doesn’t verify the patient’s health insurance, It knows that a high proportion of fees for emergency care provided will not be collected. In 2012, it bills customers $50 million. By the end of the year, $20 million remains due from customers. Of this amount, it estimates that 30% is likely to be uncollected. Assuming Kimzey uses Percentage-of-receivables method; the year-end adjusting entry to allow for these future uncollectible accounts is as follows:

Kimzey specializes in emergency outpatient care. It doesn’t verify the patient’s health insurance, It knows that a high proportion of fees for emergency care provided will not be collected. In 2012, it bills customers $50 million. By the end of the year, $20 million remains due from customers. Of this amount, it estimates that 30% is likely to be uncollected. Assuming Kimzey uses Percentage-of-receivables method; the year-end adjusting entry to allow for these future uncollectible accounts is as follows:

December 31, 2012 ($ in millions) Debit Credit6

Allowance for Uncollectible Accounts. . . . . . . . . . . . 6($20 million X 30% = $6 million)



Net Income

-6 = -6 = -6+6

Stockholders’ Equity

Bad Debt Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Balance Sheet Income Statement

5-17

Bad Debt Expense

o Equals the amount of the adjustment to the allowance for uncollectible accounts, representing the cost of estimated future bad debts charged to the current period. We include this expense in the same income statement as the credit sales with which these uncollectible accounts are associated.

o There is no cash outflow associated with bad debts.

o It is not possible to record actual future bad debts in the current period because we don’t know the future expense when preparing the current period’s financial statements.

o Equals the amount of the adjustment to the allowance for uncollectible accounts, representing the cost of estimated future bad debts charged to the current period. We include this expense in the same income statement as the credit sales with which these uncollectible accounts are associated.

o There is no cash outflow associated with bad debts.

o It is not possible to record actual future bad debts in the current period because we don’t know the future expense when preparing the current period’s financial statements.

5-18

Partial Income Statement Showing Estimated Bad Debt Expense

50(6)44

Credit sales

KIMZEY MEDICAL CLINICIncome Statement (partial)For the year ended 2012

($ in millions)

Bad debt expense

In the 2012 income statement, we reduce the $50 million of revenue from credit sales by $6 million for estimated future bad debts.

In the 2012 income statement, we reduce the $50 million of revenue from credit sales by $6 million for estimated future bad debts.

5-19

Match Future Bad Debts with Current Credit Sales

After we adjust for future uncollectible accounts, the accounts receivable portion of Kimzey’s year-end balance sheet appears below:

After we adjust for future uncollectible accounts, the accounts receivable portion of Kimzey’s year-end balance sheet appears below:

5-20

LO4 Apply the procedure to write off accounts receivable as uncollectible

On February 23, 2013, Kimzey receives notice that one of its former patients, Bruce, has filed for bankruptcy. He believes it is unlikely Bruce will pay his account of $4,000. Remember, Kimzey previously allowed for the likelihood that some of its customers would not pay. Now it knows a specific customer will not pay, it can adjust the allowance and reduce the accounts receivable. Kimzey makes the following entry.

On February 23, 2013, Kimzey receives notice that one of its former patients, Bruce, has filed for bankruptcy. He believes it is unlikely Bruce will pay his account of $4,000. Remember, Kimzey previously allowed for the likelihood that some of its customers would not pay. Now it knows a specific customer will not pay, it can adjust the allowance and reduce the accounts receivable. Kimzey makes the following entry.

February 23, 2013 Debit Credit 4,000

Accounts Receivable ................................................... 4,000 (Write off a customer’s account )



Net Income

+4000 =-4000

0

Allowance for Uncollectible Accounts .............................


5-21

Collection of Accounts previously Written Off

Later in 2013, on September 8, Bruce’s bankruptcy proceedings are complete. Kimzey had expected to receive none of the $4,000 Bruce owed. After liquidating all assets, Bruce is able to pay each of his creditors 25% of the amount due them. Kimzey records the following two entries.

Later in 2013, on September 8, Bruce’s bankruptcy proceedings are complete. Kimzey had expected to receive none of the $4,000 Bruce owed. After liquidating all assets, Bruce is able to pay each of his creditors 25% of the amount due them. Kimzey records the following two entries.

September 8, 2013 Debit Credit 1,000

Allowance for Uncollectible Accounts ................. 1,000 (Reestablish portion of account previously written off )

1,000 Accounts Receivable ................................................... 1,000 (Collect cash on account )

Cash .........................................................................

Accounts Receivable................................................

5-22

Balance of Kimzey’s Net Accounts Receivable

o Total accounts written off by Kimzey during 2013 equaled $5 million but that $1 million of this amount was collected by the end of the year. The timeline of events related to accounts receivable during 2012 and 2013 is this:(1) Accounts receivable total $20 million at the end of 2012.(2) Made an adjusting entry at the end of 2012 for estimated bad debts

of $6 million. (3) Actual accounts wrote off as uncollectible in 2013 total $5 million.(4) Of the $5 million written off, $1 million later appears receivable.(5) Received $1 million cash for the accounts re-established in (4).

o Total accounts written off by Kimzey during 2013 equaled $5 million but that $1 million of this amount was collected by the end of the year. The timeline of events related to accounts receivable during 2012 and 2013 is this:(1) Accounts receivable total $20 million at the end of 2012.(2) Made an adjusting entry at the end of 2012 for estimated bad debts

of $6 million. (3) Actual accounts wrote off as uncollectible in 2013 total $5 million.(4) Of the $5 million written off, $1 million later appears receivable.(5) Received $1 million cash for the accounts re-established in (4).

($ in millions)(4) (5)

(1) (2) (3) Reestablish Collect Cash

Accounts Receivable Total $20

EstimateBad Debts in2013 to be $6

Write Off Actual BadDebts of $5

Previous Write-offs of

$1

from PreviousWrite-offs of

$1Accts. receiv. $20 $20 $15 $16 $15

Less: Allowance (0) (6) (1) (2) (2)Net accts. receiv. $20 $14 $14 $14 $13

2012 2013($ in millions)

(4) (5)(1) (2) (3) Reestablish Collect Cash

Accounts Receivable Total $20

EstimateBad Debts in2013 to be $6

Write Off Actual BadDebts of $5

Previous Write-offs of

$1

from PreviousWrite-offs of

$1Accts. receiv. $20 $20 $15 $16 $15

Less: Allowance (0) (6) (1) (2) (2)Net accts. receiv. $20 $14 $14 $14 $13

2012 2013

5-23

Estimating Uncollectible Accounts in the following year

At the end of 2013, Kimzey must once again estimate uncollectible accounts and make a year-end adjusting entry. Suppose that in 2013 it bills customers for services $80 million, and $30 million are still receivable at the end of the year. Of $30 million receivable, it estimates 30% will not be collected. For what amount would it record the year-end adjusting entry for bad debts in 2013?

The current balance of the allowance account is :

At the end of 2013, Kimzey must once again estimate uncollectible accounts and make a year-end adjusting entry. Suppose that in 2013 it bills customers for services $80 million, and $30 million are still receivable at the end of the year. Of $30 million receivable, it estimates 30% will not be collected. For what amount would it record the year-end adjusting entry for bad debts in 2013?

The current balance of the allowance account is :

Write offaccount

Collection of previous write-offBalance before adjustmentYear-end adjustmentEstimated ending balance for 2013

Allowance for Uncollectible Accounts($ in millions)

?2

Beginning balance for 2013

9

56

1

5-24


Based on all available information at the end of 2013, Kimzey estimates that the allowance for uncollectible accounts should be $9 million. Allowance account needs to increase from its current balance of $2 million credit to the estimated ending balance of $9 million credit. It can accomplish this by adjusting the account for $7 million as follows:

Based on all available information at the end of 2013, Kimzey estimates that the allowance for uncollectible accounts should be $9 million. Allowance account needs to increase from its current balance of $2 million credit to the estimated ending balance of $9 million credit. It can accomplish this by adjusting the account for $7 million as follows:

December 31, 2013 Debit Credit7

Allowance for Uncollectible Accounts .................... 7(Estimate future bad debts)

Bad Debt Expense ..............................................................

5-25


$30 (9)

$21Net accounts receivableLess: Allowance for uncollectible accounts

AssetsCurrent assets ($ in millions):

December 31, 2013

KIMZEY MEDICAL CLINICBalance Sheet (partial)

Accounts receivable

$80

$7 50 57

$23

KIMZEY MEDICAL CLINICIncome Statement

For the year ended 2013

Net income

($ in millions) Revenue from credit salesExpenses:

Bad debt expenseOther operating expenses

5-26

LO5 Use the aging method to estimate future uncollectible accounts

o Management can estimate this percentage using historical averages, current economic conditions, industry comparisons, or other analytical techniques.

o A more accurate method than assuming a single percentage uncollectible for all accounts is to consider the age of various accounts receivable, and use a higher percentage for “old” accounts than for “new” accounts. This is known as the aging method.

o For instance, accounts that are 60 days past due are older than accounts that are 30 days past due. The older the account, the less likely it is to be collected

o Management can estimate this percentage using historical averages, current economic conditions, industry comparisons, or other analytical techniques.

o A more accurate method than assuming a single percentage uncollectible for all accounts is to consider the age of various accounts receivable, and use a higher percentage for “old” accounts than for “new” accounts. This is known as the aging method.

o For instance, accounts that are 60 days past due are older than accounts that are 30 days past due. The older the account, the less likely it is to be collected

5-27

Use the aging method to estimate future uncollectible accounts

Kimzey Medical Clinic – How aging of accounts receivable can be used to estimate uncollectible accounts. Recall that accounts receivable at the end of 2013 totaled $30 million. The image below shows its accounts receivable aging schedule at the end of 2013.

Kimzey Medical Clinic – How aging of accounts receivable can be used to estimate uncollectible accounts. Recall that accounts receivable at the end of 2013 totaled $30 million. The image below shows its accounts receivable aging schedule at the end of 2013.

($ in millions)

Age Group (days past due)

Accounts Receivable X

EstimatedPercent

Uncollectible =EstimatedAllowance

0–60 $20 20% $4.061–120 5 30% 1.5

121–180 4 40% 1.6 More than 180 $1 90% 0.9

$30 $8.0

5-28

Use the aging method to estimate future uncollectible accounts

Write off Beginning balance for 2013account

Collection of previous write-offBalance before adjustmentYear-end adjustmentEstimated ending balance for 2013

Allowance for Uncollectible Accounts($ in millions)

65

12?8


Allowance for Uncollectible Accounts ...................... 6(Estimate future bad debts)

Bad Debt Expense..............................................................

5-29

LO6 Contrast the allowance method and direct write-off method when accounting for uncollectible accounts

Suppose a company provides services for $10,000 on account in 2012, but makes no allowance for uncollectible accounts at the end of the year. On September 17, 2013, $2,000 is considered uncollectible. The company records the write-off as follows.

Suppose a company provides services for $10,000 on account in 2012, but makes no allowance for uncollectible accounts at the end of the year. On September 17, 2013, $2,000 is considered uncollectible. The company records the write-off as follows.

o Recording bad debt expense at the time we know the account to be uncollectible.

o The direct write-off method is used for tax purposes but is generally not permitted for financial reporting.

o Recording bad debt expense at the time we know the account to be uncollectible.

o The direct write-off method is used for tax purposes but is generally not permitted for financial reporting.

Direct Write-Off Method

September 17, 2013 Debit Credit2,000

Accounts Receivable ................................................ 2,000(Write off uncollectible account directly )

Bad Debt Expense ..............................................................

5-30

Comparison of the Allowance Method and the Direct

Write-off Method for Recording Uncollectible Accounts

Assume that by the end of 2012 we estimate $2,000 of accounts receivable won’t be collected. Also assume that our estimate of future bad debts turns out to be correct, and actual bad debts in 2013 total $2,000.

Assume that by the end of 2012 we estimate $2,000 of accounts receivable won’t be collected. Also assume that our estimate of future bad debts turns out to be correct, and actual bad debts in 2013 total $2,000.

($ in millions)(Year-end estimated bad debts = $2000) (Actual bad debts = $2000)

Allowance method 2,000 Allowance 2,000(estimate) 2,000 Accounts Receivable 2,000

Direct write-off method 2,000Accounts Receivable 2,000

2012 2013

No Adjustment Bad Debt Expense

Allowance

Year-end adjusting entry Write-off entry

Bad Debt Expense

($ in millions)(Year-end estimated bad debts = $2000) (Actual bad debts = $2000)

Allowance method 2,000 Allowance 2,000(estimate) 2,000 Accounts Receivable 2,000

Direct write-off method 2,000Accounts Receivable 2,000

2012 2013

No Adjustment Bad Debt Expense

Allowance

Year-end adjusting entry Write-off entry

Bad Debt Expense

5-31

Part C

Notes Receivable

5-32

LO7 Apply the procedure to account for notes receivable, including interest calculation

o Notes receivable are similar to accounts receivable but are more formal credit arrangements evidenced by a written debt instrument, or note.

o Notes receivables are classified as either Current or Noncurrent depending on the expected collection date.

o If the time to maturity is longer than one year, the note receivable is a long-term asset.

o Notes receivable are similar to accounts receivable but are more formal credit arrangements evidenced by a written debt instrument, or note.

o Notes receivables are classified as either Current or Noncurrent depending on the expected collection date.

o If the time to maturity is longer than one year, the note receivable is a long-term asset.

5-33

Notes Receivable

February 1, 2012, Kimzey Medical Clinic provides services of $10,000 to a patient, Justin Payne, who is not able to pay immediately. In place of payment, Justin offers Kimzey a six-month, 12% promissory note. An example of a typical note receivable is shown below. It records the note as follows.

February 1, 2012, Kimzey Medical Clinic provides services of $10,000 to a patient, Justin Payne, who is not able to pay immediately. In place of payment, Justin offers Kimzey a six-month, 12% promissory note. An example of a typical note receivable is shown below. It records the note as follows.

February 1, 2012 Debit Credit10,000

Service Revenue ............................................................ 10,000(Accept a six-month, 12% note receivable for services provided)

Notes Receivable ............................................................

5-34

Interest Calculation

Many of the same issues we discussed concerning accounts receivable, apply also to notes receivable. One issue that applies to notes receivable but not accounts receivable is interest.

Many of the same issues we discussed concerning accounts receivable, apply also to notes receivable. One issue that applies to notes receivable but not accounts receivable is interest.

Kimzey issued a six-month, 12% promissory note. It will charge Justin Payne one-half year of interest. Interest on its note receivable is calculated as follows.

Kimzey issued a six-month, 12% promissory note. It will charge Justin Payne one-half year of interest. Interest on its note receivable is calculated as follows.

5-35

Collection of Notes Receivables

We record the collection of notes receivable the same way as a collection of accounts receivable, except we record interest earned as interest revenue in the income statement.

August 1, 2012, the maturity date, Justin repays the note and interest in full as promised. Kimzey will record the following entry.

We record the collection of notes receivable the same way as a collection of accounts receivable, except we record interest earned as interest revenue in the income statement.

August 1, 2012, the maturity date, Justin repays the note and interest in full as promised. Kimzey will record the following entry.

August 1, 2012 Debit Credit10,600

Notes Receivable .......................................................... 10,000Interest Revenue ........................................................... 600(Collect note receivable and interest)(Interest revenue = $10,000 × 12% × 6/12 )

Cash ...........................................................................

5-36

Accrued Interest

o It happens that notes are issued in one year and the maturity date occurs in the following year. o What if Justin issued the previous six-month note to

Kimzey on November 1, 2012, instead of February 1, 2012?

o $10,000 face value and $600 interest on the six-month note are not due until May 1, 2013.

o The length of the note and interest rate remain the same, the total interest charged to Justin remains the same.

o Kimzey will record interest revenue for two months of the six-month note, and four months in the next year.

o It happens that notes are issued in one year and the maturity date occurs in the following year. o What if Justin issued the previous six-month note to

Kimzey on November 1, 2012, instead of February 1, 2012?

o $10,000 face value and $600 interest on the six-month note are not due until May 1, 2013.

o The length of the note and interest rate remain the same, the total interest charged to Justin remains the same.

o Kimzey will record interest revenue for two months of the six-month note, and four months in the next year.


Interest Revenue .......................................................... 200(Accrue interest revenue)(Interest revenue = $10,000 ×12% × 2/12 )

Interest Receivable .................................................

5-37

Remember, interest is earned as time goes by, so Kimzey earns two months’ interest ($200) in 2012 even though it won’t collect it until 2013. On May 1, 2013, the maturity date, It records the collection of the note receivable and interest receivable as well as the revenue related to four months’ interest earned in 2013.

Remember, interest is earned as time goes by, so Kimzey earns two months’ interest ($200) in 2012 even though it won’t collect it until 2013. On May 1, 2013, the maturity date, It records the collection of the note receivable and interest receivable as well as the revenue related to four months’ interest earned in 2013.

May 1, 2013 Debit Credit10,600

Notes Receivable .......................................................... 10,000Interest Receivable ........................................................ 200Interest Revenue ........................................................... 400(Collect note receivable and interest)(Interest revenue = $10,000 × 12% × 4/12)

Cash............................................................

Accrued Interest

5-38

Calculating Interest Revenue over Time for Kimzey Medical Clinic

On May 1, 2013, Kimzey has received the note receivable recorded on November 1, 2012, and the interest receivable recorded on December 31, 2012, and has eliminated their balances. The remaining four months’ interest occurs in 2013 and it recognizes as revenue then. Interest receivable from its six-month, $10,000, 12% note is $100 per month (= $10,000 x 12% x 1/12).

On May 1, 2013, Kimzey has received the note receivable recorded on November 1, 2012, and the interest receivable recorded on December 31, 2012, and has eliminated their balances. The remaining four months’ interest occurs in 2013 and it recognizes as revenue then. Interest receivable from its six-month, $10,000, 12% note is $100 per month (= $10,000 x 12% x 1/12).

5-39

LO8 Calculate key ratios investors use to monitor a company’s effectiveness in managing receivables

o The amount of a company’s accounts receivable is influenced by a variety of factors, including the level of sales, the nature of the product or service sold, and credit and collection policies.

o More liberal credit policies—allowing customers a longer time to pay or offering cash discounts for early payment—often are initiated with the specific objective of increasing sales volume.

o Management’s choice of credit and collection policies results in trade-offs.

o Investors, creditors, and financial analysts can gain important insights by monitoring a company’s investment in receivables.

o Two important ratios that help in understanding the company’s effectiveness in managing receivables are the

o receivables turnover ratio and o the average collection period.

o The amount of a company’s accounts receivable is influenced by a variety of factors, including the level of sales, the nature of the product or service sold, and credit and collection policies.

o More liberal credit policies—allowing customers a longer time to pay or offering cash discounts for early payment—often are initiated with the specific objective of increasing sales volume.

o Management’s choice of credit and collection policies results in trade-offs.

o Investors, creditors, and financial analysts can gain important insights by monitoring a company’s investment in receivables.

o Two important ratios that help in understanding the company’s effectiveness in managing receivables are the

o receivables turnover ratio and o the average collection period.

5-40

Receivables Turnover Ratio

It shows the number of times during a year that theaverage accounts receivable balance is collected.

It shows the number of times during a year that theaverage accounts receivable balance is collected.

Receivables turnover ratio = Net Credit Sales

Average accounts receivable

Average collection period = 365 Days

Receivables turnover ratio

The average collection period is another way to expressthe same measure. It shows the approximate number ofdays the average accounts receivable balance isoutstanding.

The average collection period is another way to expressthe same measure. It shows the approximate number ofdays the average accounts receivable balance isoutstanding.

5-41

Net credit sales are $400,000 for the year and the average accounts receivable balance is $40,000. We could say the turnover ratio is 10, or average receivables were collected 10 times during the year. If the turnover is 10 times a year (365 days), then the average balance is collected every 36.5 days.

Net credit sales are $400,000 for the year and the average accounts receivable balance is $40,000. We could say the turnover ratio is 10, or average receivables were collected 10 times during the year. If the turnover is 10 times a year (365 days), then the average balance is collected every 36.5 days.

Receivables Turnover Ratio

Receivables turnover ratio = = 10

Average collection period = = 36.5 days10

$400,000

($35,000 + $45,000)/2

365 days

5-42

Appendix

Percentage-of-Credit Sales Method

5-43

LO9 Estimate uncollectible accounts using the percentage-of-credit sales method

Percentage-of-receivablesmethod

Based on the estimate of bad debts on a balance sheet

amount—accounts receivable

Balance sheet method

Percentage-of-Credit-sales method

Based on the estimate of bad debts on an income statement

amount—credit sales

Income statement method

5-44

Adjusting for Estimates of Uncollectible Accounts

Bad Debt Expense 7 Bad Debt Expense 8Allowance for Uncoll. Accts. 7 Allowance for Uncoll. Accts. 8

Adjusting Entry ($ in millions)Adjusting Entry ($ in millions)

5-45

Financial Statement: Effects of Estimating Uncollectible Accounts

Percentage-of-Receivables Method Percentage-of-Credit-Sales Method($ in millions) ($ in millions)

Income Statement Effect Income Statement EffectRevenues $80 Revenues $80 Bad debt expense (7) Bad debt expense (8)Net Income $73 Net Income $72

Balance Sheet Effect Balance Sheet EffectAccounts receivable $30 Accounts receivable $30

Less: Allowance (9) * Less: Allowance (10) *$21 $20

* $9 = $2 + $7 (adjustment) * $10 = $2 + $8 (adjustment)

5-46

End of chapter 05

5-47

Chapter 05 lecture

Economy & Finance

Transcript of Chapter 05 lecture