Receivables Chapter 8 Chapter 8 explains receivables. 1 1 1 1 1.

Receivables Chapter 8 Chapter 8 explains receivables. 1 1 1 1 1

Learning Objectives Define and explain common types of receivables
Account for notes receivable Use the allowance method to account for uncollectibles Understand the direct write-off method for The objectives for this chapter include to: 1. Define and explain common types of receivables and review internal controls for receivables. 2. Use the allowance method to account for uncollectibles. 3. Understand the direct write-off method for uncollectibles. 4. Journalize credit-card and debit-card sales.

Learning Objectives Report receivables on the balance sheet and evaluate a company using the acid-test ratio, days’ sales in receivables, and the accounts receivable turnover ratio Additional objectives include to: 5. Account for notes receivable. 6. Report receivables on the balance sheet and evaluate a company using the acid-test ratio, days’ sales in receivables, and the accounts receivable turnover ratio. 7. Discount a note receivable (see Appendix 8A).

Define and explain common types of receivables
1 Define and explain common types of receivables The first learning objective is to define and explain common types of receivables and review internal controls for receivables

Receivables An asset originating from selling goods or services to another party on credit Right to receive cash in the future from such a transaction Accounts receivable Repeating transactions, less formal Control account Subsidiary ledgers Notes receivable Individual signed instance Detailed terms Often long-term You have a receivable when you sell goods or services to another party on credit. The receivable is the seller’s claim for the amount of the transaction. You also have a receivable when you loan money to another party. So a receivable is really the right to receive cash in the future from a current transaction. It is something the business owns; therefore, it is an asset. The two major types of receivables are accounts receivable and notes receivable.

Control Account vs. Subsidiary Ledger
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S8-1: Different types of receivables
What is the difference between accounts receivable and notes receivable? Notes receivable include a charge for interest; accounts receivable do not. Accounts receivable are current assets; notes receivable are current or long-term assets. Notes receivable are more formal than accounts receivable. Short Exercise 8-1 reviews the different types of receivables. Notes receivable are evidenced by the debtor signing a promissory note; accounts receivable are not.

Account for notes receivable
2 The fifth learning objective is to account for notes receivable. Account for notes receivable

2/10, n/30: The 31st day What happens when a customer fails to pay their bill on the due date? The phone call – in-house collection attempt The follow up – you said this then Place a hold on their account – no more product The negotiation – compromise? Collect Convert to a note Write off

Converting Accounts Receivable to a Note Receivable
Why would a selling firm convert past due Accounts Receivable to Notes Receivable? Builds commitment to actually pay Acknowledges that the amount is owed A big legal hammer to take to court! Why would a buyer submit to this? Pauses the collection calls Stalls payment until they have funds Note interest may be less than a past due rate They want to keep doing business with the supplier

Notes Receivable Key Terms
The key terms involved with notes receivable include: ● Promissory note: A written promise to pay a specified amount of money at a particular future date. ● Maker of the note (debtor): The entity that signs the note and promises to pay the required amount; the debtor is the company that must pay the money back. ● Payee of the note (creditor): The entity to whom the maker promises future payment; the creditor is the company that loans the money. ● Principal: The amount loaned out by the payee and borrowed by the maker of the note. ● Interest: The revenue to the payee for loaning money. Interest is expense to the debtor and revenue to the creditor. ● Interest period: The period of time during which interest is computed. It extends from the original date of the note to the maturity date. Also called the note term. ● Interest rate: The percentage rate of interest specified by the note. Interest rates are almost always stated for a period of one year. A 9% note means that the amount of interest for one year is 9% of the note’s principal. ● Maturity date: The date when final payment of the note is due. Also called the due date. ● Maturity value: The sum of the principal plus interest due at maturity. Maturity value is the total amount that will be paid back.

Identifying Maturity Date
Maturity date can be: A specific date, such as March 13 Stated in terms of number of months A six-month note dated February 16, 2014, would mature on August 16, 2014 Stated in terms of number of days Must count days from issue date to maturity day How many days from Jan 11th to March 15th? Some notes specify the maturity date. For example, September 30, 2015, is the maturity date of the note shown in Exhibit 8-5. Other notes state the period of the note in days or months. When the period is given in months, the note’s maturity date falls on the same day of the month as the date the note was issued. For example, a six-month note dated February 16, 2014 would mature on August 16, 2014.

Determine the Maturity Date
A 180-day note dated February 16, 2014 matures on August 15, 2014 Let’s use an example of how to compute the maturity date when the note term is expressed in days. In this example, a 90-day note is issued March 13. First, subtract the issue date (13) from the total days in March (31). Subtract this amount (18) from the days in the note (90). That leaves 72 more days, which is more than two months. Add together the days in the next two months (April and May). Subtract that from the remaining days. In this example, the note would be due June 11th.

Computing Interest By the year By the month By the day 1 year
The formula for computing the interest is: Principal x Rate x Time. In the formula, time period represents the portion of a year that interest has accrued on the note. It may be expressed as a fraction of a year in months (#/12) or a fraction of a year in days (#/360). Keep in mind that interest rates are stated as an annual rate. Therefore, the time in the interest formula should also be expressed in terms of a fraction of the year.

Journal Entry Demonstration
The key terms involved with notes receivable include: ● Promissory note: A written promise to pay a specified amount of money at a particular future date. ● Maker of the note (debtor): The entity that signs the note and promises to pay the required amount; the debtor is the company that must pay the money back. ● Payee of the note (creditor): The entity to whom the maker promises future payment; the creditor is the company that loans the money. ● Principal: The amount loaned out by the payee and borrowed by the maker of the note. ● Interest: The revenue to the payee for loaning money. Interest is expense to the debtor and revenue to the creditor. ● Interest period: The period of time during which interest is computed. It extends from the original date of the note to the maturity date. Also called the note term. ● Interest rate: The percentage rate of interest specified by the note. Interest rates are almost always stated for a period of one year. A 9% note means that the amount of interest for one year is 9% of the note’s principal. ● Maturity date: The date when final payment of the note is due. Also called the due date. ● Maturity value: The sum of the principal plus interest due at maturity. Maturity value is the total amount that will be paid back. Sept. 30, 2014: Note originated as a conversion from past due A/R. December 31, 2014: accrue interest earned Sept. 30, 2015: receive payment in full

Your Turn: Gulf Corp. practice problem
Sep. 1: Original sales entry. Dec. 1: Conversion of A/R to Notes Receivable Dec. 31: Year end accrual of Interest Receivable & Revenue (another adjusting entry!) Mar. 1: Collection of principal & interest 18 18 99 99

Gulf Corp. practice problem
Pre-work: Sept 1st Gulf Corp. sold $1,500 of seashells to Glenn Holler, on terms 2/10, n/30. (Omit inventory/cogs effect) Journal Entry Steps Identify account & type Increase or decrease and apply debit and credit rules Journalize & check Buying inventory for cash only trades one asset for another. There is no expense involved in this transaction. A good trick is to identify the accounts involved. If there is no expense account, there is no expense involved.

Dec. 1: Conversion of A/R to Notes Receivable, 8%, due March 1st the following year. Journal Entry Steps Identify account & type Increase or decrease and apply debit and credit rules Journalize & check Buying inventory for cash only trades one asset for another. There is no expense involved in this transaction. A good trick is to identify the accounts involved. If there is no expense account, there is no expense involved.

Dec. 31: Year end accrual of Interest Receivable & Revenue (an adjusting entry!) Journal Entry Steps Identify account & type Increase or decrease and apply debit and credit rules Journalize & check Buying inventory for cash only trades one asset for another. There is no expense involved in this transaction. A good trick is to identify the accounts involved. If there is no expense account, there is no expense involved.

Mar. 1: Collection of principal & interest Journal Entry Steps Identify account & type Increase or decrease and apply debit and credit rules Journalize & check Buying inventory for cash only trades one asset for another. There is no expense involved in this transaction. A good trick is to identify the accounts involved. If there is no expense account, there is no expense involved.

Dishonored Notes Receivable
March 1st: – if the maker fails to pay the Note receivable Move the note receivable into accounts receivable Any earned interest is added to the new accounts receivable Journal Entry Steps Identify account & type Increase or decrease and apply debit and credit rules Journalize & check If the maker of a note does not pay at maturity, the maker dishonors (defaults on) the note. Because the note has expired, it is no longer in force. But the debtor still owes the payee. The payee can transfer the note receivable amount to Accounts receivable, and then bill customer for the account receivable.

Dishonored Notes Receivable
March 1st: if the maker fails to pay the Note receivable Move the note receivable into accounts receivable Any earned interest is added to the new accounts receivable Journal Entry Steps Identify account & type Increase or decrease and apply debit and credit rules Journalize & check If the maker of a note does not pay at maturity, the maker dishonors (defaults on) the note. Because the note has expired, it is no longer in force. But the debtor still owes the payee. The payee can transfer the note receivable amount to Accounts receivable, and then bill customer for the account receivable.

Use the allowance method to account for uncollectibles
3 Use the allowance method to account for uncollectibles The second learning objective is use the allowance method to account for uncollectibles.

Why sell on credit instead of cash?
That will be $25,000 cash please. Would you take it home today if I gave you 5 years to pay? Credit terms increase the customer base, and per-customer volume. Not by a little, but by a LOT.

What is the optimal amount of credit to extend?
Many high-risk customers Many defaults Few customers No defaults Many customers Moderate defaults Where is the sweet spot? Cash Only Credit For All Maximize profits where the expected cost of default from the worst acceptable credit risk = the profits gained from selling to that customer. (Marginal cost = Marginal revenue)

Accounting for Uncollectible accounts (Bad Debts)
Two methods to account for uncollectible accounts: Allowance method – GAAP approved Matches default expense with sales revenue Direct write-off method – Rarely GAAP legal Disregards the matching principle The risk of default is taken when the sale is made. This is what ultimately causes the default An estimated expense should be entered even before accounts actually default Selling on credit brings both a benefit and a cost. The benefit is that it can increase revenues and profits by making sales to a wider range of customers. The costs, however, is that some customers don’t pay, and that creates an expense called uncollectible account expense, doubtful account expense, or bad debt expense. All three account names mean the same thing—a customer did not pay his or her account balance. There are two methods of accounting for uncollectible receivables–the allowance method or in certain limited cases, the direct write-off method.

Estimating Uncollectibles
Companies use their history, and industry information to estimate uncollectibles Percent-of-sales approach Aka: Income-statement approach Estimates uncollectible accounts as a percent of sales Aging-of-accounts Aka: Balance-sheet approach Determine target allowance based on detailed receivables balances Companies use their past experience as well as considering the economy, the industry they operate in, and other variables to estimate uncollectibles. There are two basic ways to estimate uncollectible–percent-of-sales and aging-of-accounts. The percent-of-sales method computes uncollectible account expense as a percentage of net credit sales. This method is also called the income-statement approach because it focuses on the amount of expense. The other approach for estimating uncollectible receivables is the aging-of-accounts method. This method is also called the balance-sheet approach because it focuses on the actual age of the accounts receivable and determines a target allowance balance from that age.

Allowance Method: Income statement approach
All hail the matching principle Expense amount based on percentage of sales Cares little about balance sheet accuracy Estimate future default by multiplying a default rate times sales revenue. Prepare an adjusting entry to: Record the default expense Dump the credit into an allowance account for future write off use Most companies use the allowance method to measure bad debts. The allowance method is based on the matching principle; the key concept is to record uncollectible accounts expense in the same period as the sales revenue. The offset to the expense is to a contra account called allowance for uncollectible accounts (or the allowance for doubtful accounts). The business doesn’t wait to see which customers will not pay. Instead, it records a bad debt expense based on estimates developed from past experience and uses the allowance for uncollectible accounts to house the pool of “unknown” bad debtors.

Hollywood hangout estimates that 1% of the sales will be uncollectable. Perform their period end adjusting entry.

What effect did that $1,000 adjusting entry have on Hollywood’s books?

S8-3 : Applying the allowance method (percent-of-sales) to account for uncollectibles
During its first year of operations, Spring Garden Plans earned revenue of $322,000. Industry experience suggests that bad debts will amount to 2% of revenues. At December 31, 2012, accounts receivable total $36,000. The company uses the allowance method to account for uncollectibles. Journalize Spring’s uncollectible account expense adjustment using the percent-of sales method. Short Exercise 8-3 addresses applying the allowance method (through percent–of-sales) to account for uncollectibles. 2

ACCOUNTS AND EXPLANATIONS
S8-3: Applying the allowance method (percent-of-sales) to account for uncollectibles Journal Entry DATE ACCOUNTS AND EXPLANATIONS DEBIT CREDIT Dec 31 Accounts receivable 322,000 Sales revenue 31 Uncollectible account expense (322,000 x .02) 6,440 Allowance for uncollectible accounts Journalize Spring’s sales and uncollectible account expense using the percent-of sales method. The exercise continues on this slide.

S8-3: Applying the allowance method (percent-of- sales) to account for uncollectibles
2. How much should you report as Net Accounts Receivable on the balance sheet after that adjusting entry? Balance sheet (Partial): Accounts receivable $36,000 Less: Allowance for uncollectible accounts $ 6,440 Accounts receivable, net $29,560 The exercise continues here.

Allowance Method: balance sheet approach
Calculates default expectations based on the amount of unpaid customer accounts still on then books That’s Accounts receivable The resulting calculation belongs on the balance sheet That’s the ending balance for the allowance account Use whatever expense amount it takes to get the balance sheet correct Note, this is a new step!

Balance Sheet Approach: Aging Method

Accounting for Uncollectible Accounts
Based on the aging of their receivables, Hollywood hangout estimates that $750 of their A/R balance will be uncollectable. Perform their period end adjusting entry.

Aging method adjusting entry calculation detail
Expect not to collect Total A/R

What effect did that $700 adjusting entry have on Hollywood’s books?

Your turn: Aging method adjusting entry
Perform the adjusting entry to arrive at the desired balance in the allowance account

Balance Sheet Approach: Aging Method
Focuses on actual age of the accounts receivable Determines a target allowance balance AR Total The aging method has two steps. First, the aging schedule is prepared. The total of the schedule is what the allowance for uncollectible account balance should equal (the target balance). Second, this amount is compared to the current balance in the allowance account. Uncollectible account expense will equal the difference between the allowance account and the target balance based on the aging schedule. Expected not to collect

Aging Method The amount not expected to be collected becomes the allowance account target balance Journal entry $150 credit balance plus/minus adjustment = $400 The aging method tells you what the credit balance of the allowance account needs to be—the target allowance balance. The allowance journal entry is computed based upon its current balance. After posting, the accounts are up-to-date and ready for the balance sheet.

Age of Accounts Receivable
S8-5: Applying the allowance method (aging-of-accounts) to account for uncollectibles Summer and Sandcastles Resort had the following balances at December 31, 2012, before the year-end adjustments: The aging of accounts receivable yields the following data: Accounts receivable Allowance for uncollectible accounts 78, Beg Bal ,900 Age of Accounts Receivable 0-60 days Over 60 Days Total Receivables Amount receivable $75,000 $3,000 $78,000 % uncollectible × 4% × 24% Amount uncollectible + $720 = $ 3,720 Short Exercise 8-5 applies the allowance method (aging-of-accounts) to account for uncollectibles.

S8-5 : Applying the allowance method (aging-of-accounts) to account for uncollectibles Journalize Summer’s entry to adjust the allowance account to its correct balance at December 31, 2012. Prepare a T-account to compute the ending balance of Allowance for uncollectible accounts. Journal Entry DATE ACCOUNTS AND EXPLANATIONS DEBIT CREDIT 2012 Dec 31 Uncollectible account expense ($3,720 − $1,900) 1,820 Allowance for uncollectible accounts The exercise continues on this slide. Accounts receivable Allowance for uncollectible accounts 78, Beg Bal ,900 Adj ,820 End Bal ,720 _ __________________________________________

Identifying and writing off customers who don’t pay
When we know we aren’t going to collect from a particular customer, we have to take their accounts receivable off of our books The A/R is now worthless Our books should reflect this reality Issues: We already expensed this as an estimate We are storing the expense in the allowance account Mechanics: Reduce A/R amount Use the allowance account to offset it

Writing off and uncollectible account
Surprise! On February 14th Paris Hilton answers our collection call. She refuses to pay her $500 bar tab because she doesn’t even remember being there. We know we don’t have a prayer of collecting, so we write if off. Journalize that.

Under the allowance method, the actual write-off does not involve another expense
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Recovery of Account Sometimes a customer will pay the amount owed after the customer’s account is written off Two entries needed to collect Paris reconsidered $500 payment: Reinstate her Accounts receivable. Record the payment. When an account receivable is written off as uncollectible, the receivable does not die–the customer still owes the money. However, the company stops pursuing collection and writes off the account as uncollectible. Some companies turn delinquent receivables over to an attorney or other collection agency to recover some of the cash for them. If a company writes off a specific account receivable and then receives payment, two entries are needed. To account for this recovery, the company must reverse the effect of the earlier write-off to the allowance account and record the cash collection.

Summary of Entries Make sales on account
Establish a pool (allowance) for future potential uncollectibility Collect cash on account from most customers Possibly convert some A/R to Notes receivables Identify bad debts and write them off Reinstate & collect some written off accounts The steps in the allowance process consist of: Making sales on account. Establishing a pool for future potential uncollectibility (2%). Collecting cash on account. Identifying a bad debt. Adjusting the allowance account to reflect adjustments to the estimate. Recovering a previously written-off account.

Understand the direct write-off method for uncollectibles
3 The third learning objective is to use the direct write-off method to account for uncollectibles. Understand the direct write-off method for uncollectibles

Direct Write-Off Method
Used by small businesses Used by large all-cash-sales businesses No Allowance for uncollectible accounts Record uncollectible accounts expense when specific account is written off There is another way to account for uncollectible receivables that is primarily used by small, non-public companies. It is called the direct write-off method. Under the direct write-off method, you do not use the Allowance for uncollectible accounts account to record the expense based on an estimate. Instead, you wait until you determine that you will never collect from a specific customer. Then, you write off the customer’s account receivable by debiting Uncollectible account expense and crediting the customer’s Account receivable.

Problems with Direct Write-Off Method
Overstates Accounts receivable on the balance sheet No contra asset allowance account Incents forestalling of write offs. Violates matching principle Uncollectible account expense often not in same period as sale All hail materiality! The direct write-off method is defective for two reasons: 1. It does not set up an allowance for uncollectible account. As a result, the direct write-off method always reports Accounts receivables at their full amount. So, assets are overstated on the balance sheet. 2. It does not match Uncollectible account expense against revenue very well. Many times, accounts aren’t deemed uncollectible until the following period. Therefore, the expense is not recorded in the same period as the revenue.

Direct Write-Off Recovery of Debt
Direct write-off of debt recovery process is different from the allowance method The debt was written off the books To recover: Reverse the write-off journal entry Record the cash payment As with the allowance method, under the direct write-off method, an account receivable that is written off as uncollectible does not die–the customer still owes the money. However, the accounting between the two methods differs slightly. To account for this recovery, the company must reverse the effect of the earlier write-off to the Uncollectible account expense account and record the cash collection.

S8-7: Collecting a receivable previously written off—direct write-off method
Gate City Cycles had trouble collecting its account receivable from Sue Ann Noel. On June 19, 2012, Gate City finally wrote off Noel’s $700 account receivable. Gate City turned the account over to an attorney, who hounded Noel for the rest of the year. On December 31, Noel sent a $700 check to Gate City Cycles with a note that said, “Here’s your money. Please call off your bloodhound!” 1. Journalize the entries required for Gate City Cycles, assuming Gate City uses the direct write-off method. Short Exercise 8-7 addresses collecting a receivable previously written off, using the direct write-off method.

S8-7: Collecting a receivable previously written off—direct write-off method Journal Entry DATE ACCOUNTS AND EXPLANATIONS DEBIT CREDIT Jun 19 Uncollectable account expense 700 Accounts receivable—Sue Ann Noel Dec 31 Cash Collected on account. The exercise continues on this slide.

Journalize credit-card and debit-card sales
4 The fourth learning objective is to journalize credit-card and debit-card sales. Journalize credit-card and debit-card sales

Credit Card Sales Credit-card sales are an alternative form for receiving payments Two types: Issued by a financial institution Visa Mastercard Issued by a credit card company American Express Discover Credit card sales are an alternative form of receiving payment from a customer. By accepting credit cards, businesses are able to attract more customers. There are two main types of credit cards: 1. Credit cards that are issued by a financial institution (bank or credit union). These are usually issued under the Visa and Mastercard name. 2. Credit cards that are issued by a credit card company. Common examples of this type include American Express and Discover cards. Credit cards offer the customer the convenience of buying something without having to pay cash immediately. The card issuer has the responsibility of collecting from the customer. So, instead of collecting cash from the customer, the seller will receive cash from the card issuer. There is almost always a fee to the seller to cover the processing costs.

Debit Cards Different than credit and bankcards Same as cash
Amount subtracted from buyer’s bank account Amount added to retailer’s bank account Another means by which businesses attract customers is by accepting debit card payments. From the seller’s viewpoint, debit cards have almost the same benefits as credit cards. The main difference between credit and debit cards is in how and when the customer must pay the card issuer.

Bank Cards Retailers receive cash at time of sale
Visa and MasterCard most common bank cards Retailer accepting the credit cards pays a fee Two types of fee transactions: NET: The total sale less the processing fee assessed equals the net amount of cash deposited Gross: The total sale is deposited and the fee is deducted at the end of the month Journal entry similar to cash sales The processor agreement specifies how fees are paid to the processor. Following are two common methods of deposits of proceeds: ● NET: The total sale less the processing fee assessed equals the net amount of cash deposited by the processor, usually within a few days of the sale date. ● GROSS: The total sale is deposited daily within a few days of the actual sale date. The processing fees for all transactions processed for the month are deducted from the company’s bank account by the processor, often on the last day of the month. Proceeds from credit and debit card transactions are usually deposited within a few business days. Therefore, credit and debit card sales are journalized similar to cash sales.

S8-8 : Recording credit-card and debit-card sales
Restaurants do a large volume of business by credit and debit cards. Suppose Chocolate Passion restaurant had these transactions on January 28, 2012: National Express credit-card sales $ 9,300 ValueCard debit-card sales ,000 Suppose Chocolate Passion’s processor charges a 3% fee and deposits sales net of the fee. Requirement: 1. Journalize these sale transactions for the restaurant. Short exercise 8-8 reviews how to record credit-card and debit-card sales.

S8-8 : Recording credit-card and debit-card sales
National Express credit-card sales $ 9,300 ValueCard debit-card sales ,000 Journal Entry DATE ACCOUNTS AND EXPLANATIONS POST. REF. DEBIT CREDIT Jan 28 Cash $9,021 Card discount expense ($9,300 × .03) 279 Sales revenue $9,300 Recorded credit-card sales, net of fee. 8,730 Card discount expense ($9,000 × .03) 270 9,000 Recorded bank card sales, net of fee. The exercise continues on this slide.

Evaluate accounts receivable performance
6 The sixth learning objective is to report receivables on the balance sheet and evaluate a company using the acid-test ratio, days’ sales in receivables and the accounts receivable turnover ratio. Evaluate accounts receivable performance

Acid-Test Ratio Also called the “quick ratio”
Stringent measure of liquidity Measures entity’s ability to pay its current liabilities immediately A more stringent measure of ability to pay current liabilities is the acid-test ratio (or quick ratio). The acid-test ratio reveals whether the entity could pay all its current liabilities if they were to become due immediately. The higher the acid-test ratio, the more able the business is to pay its current liabilities. What is an acceptable acid-test ratio? That depends on the industry. The acid-test is calculated as Cash plus Short-term investments plus Net current receivables divided by Total current liabilities.

Accounts Receivable Turnover Ratio
Measures the number of times the company sells and collects the average receivables Higher the ratio, the faster the cash collections occur How well a company is managing its customer credit policies The accounts receivable turnover ratio measures the number of times the company sells and collects the average receivables balance in a year. The higher the ratio, the faster the cash collections. Investors and creditors do not evaluate a company on the basis of one or two ratios. Instead, they analyze all the information available. Then they stand back and ask, “What is our overall impression of this company?” Ratios serve as benchmarks to see how well a company is managing its receivables. Accounts receivable turnover equals Net cash sales divided by Average net accounts receivable.

Days’ Sales in Receivables
Also called “collection period” It is number of days it takes to collect the average balance of receivables The shorter the collection period, the more quickly cash is available Options to calculate: Complex pathway involving too much math Calculate turns first, then divide 365 by turns After making a credit sale, the next step is to collect the receivable. Days’ sales in receivables, also called the collection period, indicates how many days it takes to collect the average level of receivables. The number of days in average accounts receivable should be close to the number of days customers are allowed to pay. The shorter the collection period, the more quickly the organization can use its cash. The longer the collection period, the less cash is available for operations. Days’ sales in receivables can be computed in two steps, as shown on the following slide.

A/R Turns and Days’ in Receivables demo
Who collects faster Budweiser or Coors? BUD - Budweiser TAP – Coors Get the numbers Do the math Read the story 20-35 days normal Lots of other normals Net Sales = A/R Turns Average A/R 365 Days’ sales in receivables = A/R Turns

Turning beer into cash: The business cycle
Add inventory information to measure the whole business cycle Who turns inventory into cash more quickly? days of inventory is norm 20-35 days of A/R is normal is a normal business cycle range

Run your numbers, and tell your story
Faster collections is less risk taking Faster inventory means better product management Faster business cycle means more times making money each year Net Sales = A/R turns 10-20 normal Average A/R 365 Days’ sales in receivables = 20-35 normal A/R Turns COGS = Inventory turns 3-4 normal Average Inv. 365 Days’ inventory on hand = normal Inventory. turns Days’ inventory on hand Days’ sales in receivables Days in the business cycle + = normal

Step 1: One day’s sales is calculated Net sales (Total revenues) divided by 365 days per year Day’s sales in receivables is calculated in a two step process. Step 1 - One day’s sales is calculated; that is, Net sales (Total revenues) divided by 365 days per year.

Step 2: Day’s sales in inventory Average net receivables divided by one days sales In Step 2, the average net accounts receivable is divided by one days sales.

How much net income did Northend earn for the month?
S8-11 : Reporting receivables and other accounts in the financial statements Northend Medical Center included the following items in its financial statements: How much net income did Northend earn for the month? Short Exercise 8-11 focuses on the reporting of receivables and other accounts in the financial statements. Service revenue ………… $14,700 Less: Cost of services sold and other expenses… 12,400 Net income ………………… $ 2,300

S8-11 : Reporting receivables and other accounts in the financial statements
2. Show two ways Northend can report receivables on its classified balance sheet: Current assets: Accounts receivable …………... $2,590 Less: Allowance for doubtful accounts ___150 Accounts receivable, net …... $ 2,440 or Accounts receivable, net of allowance for uncollectible accounts of $150…………... $2,440 The exercise continues on this page.

S8-12 : Using the acid-test ratio and days’ sales in receivables to evaluate a company
Southside Clothiers reported the following items at September 30, 2012 (last year’s—2011—amounts also given as needed): Compute Southside’s (a) acid-test ratio, (b) days’ sales in average receivables for 2012, and (c) accounts receivable turnover ratio. Evaluate each ratio value as strong or weak. Southside sells on terms of net 30. Short Exercise 8-12 addresses using the acid-test ratio and days’ sales in receivables to evaluate a company.

Southside’s position is strong.
S8-12 : Using the acid-test ratio and days’ sales in receivables to evaluate a company Acid-test ratio = Cash + Short-term investments + Net current receivables Total current liabilities = $260,000 + $140,000 + $270,000 $500,000 = $670,000 $500,000 = 1.34 Southside’s position is strong. The exercise continues on this slide.

(b) Days’ sales in average receivables = * Average net accounts receivable ** One day’s sales *Average net accounts receivable = $170, ,000/2 = *$220,000 **One day’s sale=(Net sales/365 days) = $2,920,000/365 days = **$8,000 The days’ sales in average receivables are strong relative to credit terms of net 30. *$220, **$8,000 = 28 days The exercise continues here.

(c) Accounts receivable Turnover Ratio = Net sales revenue Average net accounts receivable = $2,920,000 $220,000 = 13.3 Southside’s accounts receivable turnover ratio is strong relative to credit terms of net 30. The exercise continues on this slide.

Discount a note receivable (see Appendix 8A)
7 The seventh learning objective is to discount a note receivable. Discount a note receivable (see Appendix 8A)

Discount a Note Receivable
The payee needs cash before the maturity date Payee sells the receivables Amount is determined by present-value concepts A payee of a note receivable may need cash before the maturity date of the note. When this occurs, the payee may sell the not–a practice called discounting a note receivable. The price to be received for the note is determined by present-value concepts. But the transaction between the seller and the buyer of the note can take any form agreeable to the two parties. Here we illustrate one procedure used for discounting short-term notes receivable. To receive cash immediately, the seller accepts a lower price than the note’s maturity value.

Steps in Discounting a Note Receivable
Compute the original amount of interest on the note receivable Maturity value of the note = Principal + Interest Determine the period (number of days, months, or years) the bank will hold the note (the discount period) Compute the bank’s discount on the note This is the bank’s interest revenue from holding the note Seller’s proceeds from discounting the note receivable = Maturity value of the note – Bank’s discount on the note The proceeds can be computed in five steps, as follows: 1. Compute the original amount of interest on the note receivable. 2. Maturity value of the note = Principal + Interest. 3. Determine the period (number of days, months, or years) the bank will hold the note (the discount period). 4. Compute the bank’s discount on the note. This is the bank’s interest revenue from holding the note. 5. Seller’s proceeds from discounting the note receivable = Maturity value of the note – Bank’s discount on the note.

Example of Discounting a Note
$1,000 note is received on September 30, 2015 Maturity date is one year Note is discounted on November 30, 2014 Interest applied is 12%, and is higher than notes Amounts received is called proceeds Greg’s Tunes took a note receivable from Holland. The maturity date of the one-year, 6% Holland note is September 30, Suppose Greg’s Tunes discounts the $1,000 Holland note at First City Bank on November 30, 2014, when the note is two months old. The bank applies a 12% annual interest rate to determine the discounted value of the note. The bank will use a discount rate that is higher than the note’s interest rate in order to earn some interest on the transaction. The discounted value, called the proceeds, is the amount Greg’s Tunes receives from the bank. Step 1 – Compute the original amount of interest, $1,000 times 6% times 12 of 12 months equals $60. Step 2 – Maturity values of note is Principle plus interest, $1,000 plus $60 interest equals $1,060. Step 3 – Determine the period the bank will hold the note, 12 months minus the two months held equals 10 months. Step 4 – Computes the banks discount on the notes, $1,060 times 12% times 10 of 12 months equals $106. Step 5 – Seller’s proceeds from the note, $1,060 minus $106 equals $954.

Example of Discounting a Note
If proceeds are less than principle amount, the payee debits Interest expense If proceeds are greater than principle amount, the payee debits Interest revenue When the proceeds from discounting a note receivable are less than the principal amount of the note, the payee records a debit to Interest expense for the amount of the difference. When the proceeds from discounting the note are more than the note principal, the payee records a credit to Interest revenue.

Chapter 8 Summary The two main differences between accounts receivable and notes receivable are that : 1) accounts receivable are usually collected in a short time, such as within 30 days; and 2) notes receivable are usually longer in term and have a signed, interest-bearing document to support the note. The allowance method records Uncollectible account expense based on estimating the future potential that the company won’t collect. This estimate is based on experience, economy, and other factors. So the company knows that–historically–some percentage of customers will not pay. The two main differences between accounts receivable and notes receivable are that:1) accounts receivable are usually collected in a short time, such as within 30 days; and 2) notes receivable are usually longer in term and have a signed, interest-bearing document to support the note. The allowance method records uncollectible account expense based on estimating the future potential that the company won’t collect. This estimate is based on experience, economy, and other factors. So the company knows that–historically–some percentage of customers will not pay.

Chapter 8 Summary There is no allowance for uncollectible accounts account or estimates used for the direct write-off method. The expense is journalized at the time the company determines a customer cannot pay. Most companies accept debit and/or credit cards as payment for sales. Companies can likely increase sales by offering customers the option to pay with debit/credit cards. This also allows the company to get its cash sooner, but a small fee is paid for that convenience. There is no allowance for uncollectible accounts account or estimates used for the direct write-off method. The expense is journalized at the time the company determines a customer cannot pay. Most companies accept debit and/or credit cards as payment for sales. Companies can likely increase sales by offering customers the option to pay with debit/credit cards. This also allows the company to get its cash sooner, but a small fee is paid for that convenience.

Chapter 8 Summary Notes receivable are another form of receivable that also earn interest. Interest, whether earned or incurred, is calculated as principal x rate x time. The passage of time is what creates the interest. Accounts receivable, net of allowance, is listed in the Current asset section of the balance sheet. Notes receivable is listed as current only if the note will be collected in one year or less. Ratios serve as benchmarks to see how well a company is managing its receivables. Notes receivable are another form of receivable that also earn interest. Interest, whether earned or incurred, is calculated as principal x rate x time. The passage of time is what creates the interest. Accounts receivable, net of allowance is listed in the current asset section of the balance sheet. Notes receivable is listed as current only if the note will be collected in one year or less. Ratios serve as benchmarks to see how well a company is managing its receivables.

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Receivables Chapter 8 Chapter 8 explains receivables. 1 1 1 1 1.

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