The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Accounting for Receivables and Payables Chapter Eight 8-2 LO 1 Explain how the allowance method for bad debts affects financial statements. LO 1 8-3 Credit Terms and Bad Debts Some customers may be unwilling or unable to pay their accounts receivable. Because we do not want to overstate assets, we must show accounts receivable at its net realizable value on the balance sheet. The net realizable value is the gross amount of the receivables less some estimated allowance for doubtful accounts. Lets look at the revenue and doubtful account process. 8-4 Revenue Recognition Event 1 Revenue Recognition During 2008, Allens Tutoring Services, a service company, renders services on account for customers in the amount of $14,000. Accounts Receivable $14,000 Sales $14,000 8-5 Collection for Receivables Event 2 Collection of Receivables During the year, ATS collects cash of $12,500 on its accounts receivable. Cash $12,500 Accounts Receivable $12,500 8-6 Recognizing Bad Debts Expense Event 3 Recognizing Bad Debts Expense Based upon past experience, ATS estimates that $75 of its current accounts receivable balance will eventually prove to be uncollectible. Bad Debts Expense $75 Allowance for Doubtful Accounts $75 8-7 General Ledger Accounts 8-8 Financial Statements 8-9 Subsequent Period Event 1 Write-Off of an Uncollectible Account Receivable During 2009, ATS determines that an account receivable of $70 will not be collected. The company elects to write-off the account. Allowance for Doubtful Accounts $70 Accounts Receivable $70 8-10 Notes Receivable Event 2 Investment in Note Receivable During 2009, ATS decides to invest some idle cash. On May 1, 2009, the company loans $12,000 to another company. The note is due in one year and bears interest at an annual rate of 9%. Notes Receivable $ 12,000 Cash $12,000 8-11 Revenue Recognition Event 3 Revenue Recognition During 2009, ATS renders services on account in the amount of $10,000. Accounts Receivable $ 10,000 Service Revenue $ 10,000 8-12 Collections on Account Receivable Event 4 Collection on Accounts Receivable During 2009, ATS collects $8,430 on its accounts receivable. Cash $8,430 Accounts Receivable $8,430 8-13 Reinstate Account Receivable Event 5 Reinstatement of Account Written-Off Of the accounts receivable previously written-off, it turns out that the company will collect $10. Accounts Receivable $10 Allowance for Doubtful Accounts $10 8-14 Recovery on Account Event 6 Collection of Recovered Amount Of the accounts receivable previously written-off, it turns out that the company will collect $10. Cash $10 Accounts Receivable $10 8-15 Year-End Adjusting Entries Event 7 Adjustment for Bad Debts Expense At the end of 2009, ATS estimates that its bad debts will amount to 1.35% of its credit sales. Bad Debts Expense $135 Allowance for Doubtful Accounts $135 8-16 Interest Revenue Event 8 Recognition of Interest Revenue At the end of 2009, ATS must accrue interest on its note receivable. $12,000 9% 8/12 = $720 interest revenue Interest Receivable $720 Interest Revenue $720 8-17 General Ledger T-Accounts 8-18 Financial Statements 8-19 LO 1 Show how the direct write-off method of accounting for bad debts affects financial statements. LO 2 8-20 Direct Write-Off Method Event 1 Recognition of Revenue on Account During 2008, the company provided services of $50,000 to clients on account. 8-21 Direct Write-Off Method Event 2 Recognition of Bad Debt During 2008, the company determines that a customer who owes $200 is unable to pay. One entry onlyTake it out of Accounts Receivable and put it into Bad Debts Expense 8-22 LO 1 Explain how accounting for credit card sales affects financial statements. LO 3 8-23 Credit Card Sales Rather than maintaining a credit granting department, many companies find it cost beneficial to accept credit cards. The credit card company deducts a fee, usually between 2% and 8%, from the gross amount of the sales, and pays the merchant the net balance (gross sales less credit card fee). 8-24 Credit Card Sales Event 1 Recording a Credit Card Sale Wilson accepts a credit card in payment for services of $1,000. The credit card company charges a fee of 5% of the transaction. 8-25 Credit Card Sales Event 2 Collection of a Credit Card Receivable Wilson collects the full amount due from the credit card company. 8-26 LO 1 Explain how accounting for warranty obligations affects financial statements. LO 4 8-27 Warranty Obligations Generally within the warranty period, the seller promises to replace or repair defective products without charge to the customer. Event 1 Sale of Merchandise PPF sells $7,000 of merchandise for cash. The merchandise has a cost to the company of $4,000. Cash $7000 Sales $7000 Cost of Goods $4000 Mdse Inv $4000 8-28 Warranty Obligations Event 2 Recognition of Warranty Expense The company estimates that warranty expense associated with the current sale will be $100. Warranty Expense $100 Warranty Payable $100 8-29 Warranty Obligations Event 3 Settlement of Warranty Obligation The company pays $40 cash to repair defective merchandise returned by a customer. Warranty payable $40 Cash $40 8-30 General Ledger T-Accounts 8-31 Financial Statements 8-32 LO 1 Explain the effects of the cost of financing credit sales. LO 5 8-33 Accounts Receivable Turnover Accounts Receivable Turnover Ratio Sales Accounts Receivable = The longer it takes to collect accounts receivable, the greater the opportunity cost of lost income. 8-34 Days to Collect Receivable This ratio often helps simplify the issues surrounding the collections of accounts receivable. Average Number of Days to Collect Accounts Receivable = 365 Accounts Receivable Turnover Ratio 8-35 Operating Cycle The operating cycle is the average time it takes a business to convert inventory to accounts receivable plus the time it takes to convert accounts receivable back into cash. 8-36 LO 1 Show how discount notes and related interest charges affect financial statements. (Appendix) LO 6 Discount Notes (Appendix) 8-37 Interest on a discount note is included in the face value of the note. A $10,000 face value discount note will be repaid with $10,000 at maturity. This payment will include both principal and accrued interest. Discount Notes (Appendix) Events Event 1: Beacon Management Services was started when it issued a $10,000 face value discount note to State Bank on March 1, Notes payable$10,000 Discount on notes payable (900) Carrying value of liability$ 9,100 Discount Notes (Appendix) Events Event 2: Beacon incurred $8,000 of cash operating expense. Event 3: Beacon recognized $12,000 of cash revenue. Discount Notes (Appendix) Events Event 4: Beacon recognized accrued interest expense on December 31, $900 Discount/12 months = $75 $75 x 10 months = $750 8-41 8-42 Discount Notes (Appendix) Events Event 1: Beacon recognized 2 months of accrued interest on March 1, $900 Discount/12 months = $75 $75 x 2 months = $150 Discount Notes (Appendix) Events Event 2: Beacon repaid the face value of the discount note on March 1, 2009. Discount Notes (Appendix) 8-45 Event 4: Beacon incurred $8,500 of cash operating expense Events Event 3: Beacon recognized $13,000 of cash revenue. 8-46 8-47 8-48 End of Chapter Eight