CHAPTER 8 RECEIVABLES

Classification of Receivables • Accounts Receivable

• Credit granted to customers

• Notes Receivable

• Credit granted through a promissory note

• Other Receivables

• Resulting from loans to officers or employees

Turn to page D-5 of the NIKE, INC. Annual Report

• Describe the common classes of receivables.

A/R vs N/R

• 3 things distinguish a Note Receivable from an Account Receivable:

• 1. Notes are typically for a longer period of time

• 2. Notes typically require a formal written agreement stating due date and interest rate

• 3. Notes typically involve interest paid

Uncollectible Receivables • No matter what, some customers will not

pay what they owe you.

• When this happens, your business will incur an expense.

• Uncollectible accounts expense

• Bad debts expense

• Doubtful accounts expense

• Describe the accounting for uncollectible receivables.

Indications of None Payment

When does an account become uncollectible? 1. Past due

2. No response from customer

3. Customer files bankruptcy

4. Customer closes business

5. Company cannot locate customer

One option is to turn the account over to a collection agency. This can be very costly.

Allowance Method • This is the preferred method of write-off of bad

debt.

• Record bad debt expense by estimating uncollectible accounts.

1. Estimate the accounts that will not be collected and to

record expense before customers actually fail to pay.

2. Recognize expense in the same period that revenue was recorded.

• Describe the allowance method of accounting for uncollectible

receivables.

Example ecember 31estimates that a total of $30,000 of the

$200,000 balance of their accounts receivable will

eventually be uncollectible.

The specific customer accounts cannot be

decreased, so a contra account, Allowance

for Doubtful Accounts, is credited.

The Allowance Method

The net amount that is expected to be collected, $170,000 ($200,000 - $30,000) is called the net realizable value of the receivables. The adjusting entry reduces receivables to the NRV and matches uncollectible expenses with revenues.

Suppose you identify a customer?

• On January 21, John Parker’s account of

$6,000 is written off because it is

uncollectible.

Note that the allowance

account credited earlier is

debited at the write-off,

not Bad Debt Expense.

What happens if a customer pays his debt?

Receipt of

cash entry

Reinstatement

entry

Let’s Practice!

Demonstration Problem: Kids-At-Play toy store.

Estimating Uncollectibles

• Using the allowance method requires an estimate of uncollectible accounts at the end of the period.

• Estimate is based:

• Past experience

• Industry averages

• Forecasts of the future

• Two Methods used:

• Percentage of sales method

• Analysis of receivables method

Percentage of Sales Method • Read “Business Connection” on page 365.

Basis for the method is the amount of this year’s net sales that will not be collected.

If ExTone Company’s credit sales for the period are

$3,000,000 and it is estimated that 3/4% will be

uncollectible, Bad Debt Expense is debited for $22,500

($3,000,000 x .0075).

Example

A/R 800,000

Allowance for DA 7,500

Sales 3,500,000

Bad Debt Exp 17,500

Analysis of Receivables Method or AGING • Assumption:

• The longer an A/R is outstanding, the less likely that it will be collected.

• Basing the estimate of uncollectible accounts on how long specific amounts have been outstanding is called AGING the receivables.

1. the due date of each A/R is determined

2. the number of days each account is past due is determined. (# of days between due date of account & date of analysis.)

3. each account is placed in an aged class according to its days past due. (see next slide for classes.)

4. the totals for each aged class are determined.

5. the total of each aged class is multiplied by an estimated percentage of uncollectible accounts for that class.

6. the estimated total of uncollectible accounts is determined as the sum of the uncollectible accounts for each aged class.

Aging classes: Not Past Due, 1-30 days late, 31-60 days late, 61-90 days late, 91-180 days late, 181-365 days late, over 365 days late.

Summary of the AGING Method Refer to exhibit 1 on page 367 of text book

Example of days past due

Dated August 29, due in 30 days

Due date = September 28

Aug 29-31 = 2 days

days in Sept 30 – 2 = 28

due date September 28

Calculate # of days late as of December 31

2 days past due in Sept

31 days past due in Oct

30 days past due in Nov

31 days past due in Dec

The account is 94 days past due

A/R 800,000

Allowance for DA 7,500 22,500

Sales 3,500,000

Bad Debt Exp 22,500

Ex 8-7, 8-8 page 286 & problem 8-2A page 393

Notes Receivables vs Accounts Receivables

• Characteristics of Notes Receivables or Promissory Notes:

1. MAKER is the party making the promise to pay

2. PAYEE is the party to whom the note is payable.

3. FACE AMOUNT is the amount for which note is written on the face.

4. ISSUANCE DATE is the date a note is issued.

5. DUE DATE/MATURITY DATE is the date note is to be paid.

6. TERM of note is amount of time between issuance and due dates.

7. INTEREST RATE is rate that must be paid on the face amount for the term of the note.

• Describe the accounting for notes receivable.

Due Date of a 90-day Note What is the due date of a 90-day note dated March 16?

• Days in March 31

• Minus issuance date of note 16

• Days remaining in March 15

• Add days in April 30

• Add days in May 31

• Add days in June (due date of June 14) 14

• Term of note 90 days

Total days in note 90 days

• Number of days in March 31

• Issue date of note, March 16 (16)

• Remaining days in March days 15

• Number of days in April 30

• Number of days in May days 31

• Residual days in June (14) days

Calculate the Due Date

15 + 30 + 31 + 14 = 90 days

Calculate the Interest & Maturity Value

Interest = Face Amount x Interest Rate x(Term/360days)

Based on previous slide we calculate the interest:

Interest = 2,000 x 10% x (90/360) = $50

Maturity Value = Face Value + Interest

Based on previous slide we determine the maturity value:

Maturity Value = 2000 + 50 = 2050

Received a $6,000, 12%, 30-day note dated

November 21, 2012, in settlement of the account

of W. A. Bunn Company.

Accounting for Notes Receivable

• On December 21, when the note matures,

the firm receives $6,060 from W. A. Bunn

Company ($6,000 face amount plus $60

interest).

Reporting Receivables on the Balance Sheet

• The accounts receivable turnover measures how frequently during the year the accounts receivable are being converted to cash.

Accounts Receivable

Turnover

Net Sales

= Average Accounts

Receivable

Accounts Receivable Turnover

• Describe and illustrate the use of accounts receivable turnover and

number of days’ sales in receivables to evaluate a company’s

efficiency in collecting its receivables.

Number of Days Sales in Receivables • The number of days’ sales in receivables is an estimate of

the length of time the accounts receivable have been

outstanding. Number of Days’

Sales in

Receivables

Average Accounts Receivable

Average Daily Sales