1. 8-1 REPORTING AND ANALYZING RECEIVABLES Accounting, Fifth Edition 8

2. 8-2 After studying this chapter, you should be able to: 1. 1.Identify the different types of receivables. 2. 2.Explain how accounts receivable are recognized in the accounts. 3. 3.Describe the methods used to account for bad debts. 4. 4.Compute the interest on notes receivable. 5. 5.Describe the entries to record the disposition of notes receivable. 6. 6.Explain the statement presentation of receivables. 7. 7.Describe the principles of sound accounts receivable management. 8. 8.Identify ratios to analyze a company’s receivables. 9. 9.Describe methods to accelerate the receipt of cash from receivables. Learning Objectives

3. 8-3 Amounts due from individuals and companies that are expected to be collected in cash. Amounts customers owe on account that result from the sale of goods and services. Accounts Receivable Types of Receivables LO 1 Identify the different types of receivables. Written promise (formal instrument) for amount to be received. Also called trade receivables. Non-trade receivables such as interest, loans to officers, advances to employees, and income taxes refundable. Notes Receivable Other Receivables

4. 8-4 Amounts due from individuals and companies that are expected to be collected in cash. Types of Receivables LO 1 Identify the different types of receivables.

5. 8-5 Two accounting issues: 1.Recognizing (recording) accounts receivable. 2.Valuing accounts receivable. Accounts Receivable LO 2 Explain how accounts receivable are recognized in the accounts.  Service organization - records a receivable when it performs service on account.  Merchandiser - records accounts receivable at the point of sale of merchandise on account. Recognizing Accounts Receivable

6. 8-6 Illustration: Assume that Jordache Co. on July 1, 2014, sells merchandise on account to Polo Company for $1,000 terms 2/10, n/30. Prepare the journal entry to record this transaction on the books of Jordache Co. Accounts receivable1,000Jul. 1 Sales revenue1,000 Accounts Receivable LO 2 Explain how accounts receivable are recognized in the accounts.

7. 8-7 Illustration: On July 5, Polo returns merchandise worth $100 to Jordache Co. Sales returns and allowances100Jul. 5 Accounts receivable100 Illustration: On July 11, Jordache receives payment from Polo Company for the balance due. Cash882Jul. 11 Sales discounts ($900 x.02) 18 Accounts receivable900 Accounts Receivable LO 2 Explain how accounts receivable are recognized in the accounts.

8. 8-8 Exercise 1 Page 429

9. 8-9 Interest revenue4.50 Illustration: Some retailers issue their own credit cards. Assume that you use your JCPenney Company credit card to purchase clothing with a sales price of $300. Accounts receivable300 Sales revenue300 Assuming that you owe $300 at the end of the month, and JCPenney charges 1.5% per month on the balance due Accounts receivable4.50 Accounts Receivable LO 2 Explain how accounts receivable are recognized in the accounts.

10. 8-10 Exercise 2 Page 429

11. 8-11 Valuing Accounts Receivable  Current asset.  Valuation (net realizable value). Uncollectible Accounts Receivable  Sales on account raise the possibility of accounts not being collected.  Seller records losses that result from extending credit as Bad Debts Expense. Accounts Receivable

12. 8-12 Allowance Method Losses are estimated:   Better matching.   Receivable stated at net realizable value.   Required by GAAP. Methods of Accounting for Uncollectible Accounts Direct Write-Off Theoretically undesirable:  No matching.  Receivable not stated at net realizable value.  Not acceptable for financial reporting. Valuing Accounts Receivable LO 3 Describe the methods used to account for bad debts.

13. 8-13 How are these accounts presented on the Balance Sheet? Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 500 25 End. Accounts Receivable

14. 8-14 Accounts Receivable

15. 8-15 Alternate Presentation Accounts Receivable

16. 8-16 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 500 25 End. Journal entry for credit sale of $100? Accounts receivable100 Sales 100 Accounts Receivable

17. 8-17 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 600 25 End. Journal entry for credit sale of $100? Accounts receivable100 Sales 100 Sale 100 Accounts Receivable

18. 8-18 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 600 25 End. Sale 100 Collected $333 on account? Cash333 Accounts receivable 333 Accounts Receivable

19. 8-19 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 267 25 End. Sale 100 Collected $333 on account? Cash333 Accounts receivable 333 333 Coll. Accounts Receivable

20. 8-20 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 267 25 End. Sale 100333 Coll. Adjustment of $15 for estimated bad debts? Bad debt expense15 Allowance for Doubtful Accounts15 Accounts Receivable

21. 8-21 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 267 40 End. Sale 100333 Coll. Adjustment of $15 for estimated bad debts? Bad debt expense15 Allowance for Doubtful Accounts15 15 Est. Accounts Receivable

22. 8-22 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 267 40 End. Sale 100333 Coll. 15 Est. Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts10 Accounts receivable10 Accounts Receivable

23. 8-23 Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 257 30 End. Sale 100333 Coll. 15 Est. Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts10 Accounts receivable10 W/O 10 10 W/O Accounts Receivable

24. 8-24 Accounts Receivable

25. 8-25 Exercise 3 Page 429-430

26. 8-26 Allowance Method for Uncollectible Accounts 1.Companies estimate uncollectible accounts receivable. 2.Debit Bad Debts Expense and credit Allowance for Doubtful Accounts (a contra-asset account). 3.Companies debit Allowance for Doubtful Accounts and credit Accounts Receivable at the time the specific account is written off as uncollectible. Accounts Receivable LO 3 Describe the methods used to account for bad debts.

27. 8-27 Illustration: Hampson Furniture has credit sales of $1,200,000 in 2014, of which $200,000 remains uncollected at December 31. The credit manager estimates that $12,000 of these sales will prove uncollectible. Valuing Accounts Receivable Bad debt expense12,000Dec. 31 Allowance for doubtful accounts12,000 LO 3 Describe the methods used to account for bad debts. Recording Estimated Uncollectibles

28. 8-28 Valuing Accounts Receivable Illustration 8-3 Presentation of allowance for doubtful accounts LO 3 Describe the methods used to account for bad debts.

29. 8-29 Illustration: The vice-president of finance of Hampson Furniture on March 1, 2015, authorizes a write-off of the $500 balance owed by R. A. Ware. The entry to record the write-off is: Valuing Accounts Receivable Allowance for doubtful accounts 500Mar. 1 Accounts receivable500 Recording Write-Off of an Uncollectible Account Illustration 8-4 LO 3 Describe the methods used to account for bad debts.

30. 8-30 1 July 1 Illustration: On July 1, R. A. Ware pays the $500 amount that Hampson Furniture had written off on March 1. Hampson makes these entries: Valuing Accounts Receivable Accounts receivable 500 Allowance for doubtful accounts 500 Recovery of an Uncollectible Account Cash 500 Accounts receivable500 LO 3 Describe the methods used to account for bad debts. Helpful Hint Like the write-off, a recovery does not involve the income statement.

31. 8-31 Valuing Accounts Receivable Under the percentage of receivables basis, management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts. LO 3 Describe the methods used to account for bad debts. Estimating the Allowance Helpful Hint Where appropriate, the percentage-of- receivables basis may use only a single percentage rate.

32. 8-32 Valuing Accounts Receivable Illustration 8-7 LO 3 Describe the methods used to account for bad debts. Aging the accounts receivable - customer balances are classified by the length of time they have been unpaid.

33. 8-33 Illustration: Assume the unadjusted trial balance shows Allowance for Doubtful Accounts with a credit balance of $528. Prepare the adjusting entry assuming $2,228 is the estimate of uncollectible receivables from the aging schedule. Valuing Accounts Receivable Bad debt expense 1,700Dec. 31 Allowance for doubtful accounts 1,700 Illustration 8-8 Bad debts accounts after posting Estimating the Allowance LO 3 Describe the methods used to account for bad debts.

34. 8-34 Brule Co. has been in business five years. The unadjusted trial balance at the end of the current year shows: Accounts Receivable $30,000 Dr. Sales Revenue $180,000 Cr. Allowance for Doubtful Accounts $2,000 Dr. Bad debts are estimated to be 10% of receivables. Prepare the entry to adjust Allowance for Doubtful Accounts. Solution Bad debts expense 5,000 Allowance for doubtful accounts 5,000 * [(0.1 x $30,000) + $2,000] LO 3 Describe the methods used to account for bad debts.

35. 8-35 Illustration: Assume that Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. Warden’s entry is: Bad debt expense200 Accounts receivable200 Direct Write-off Method for Uncollectible Accounts Theoretically undesirable:  No matching.  Receivable not stated at cash realizable value.  Not acceptable for financial reporting. Accounts Receivable LO 3 Describe the methods used to account for bad debts.

36. 8-36 Notes Receivable Companies may grant credit in exchange for a promissory note. A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. Promissory notes may be used 1.when individuals and companies lend or borrow money, 2.when amount of transaction and credit period exceed normal limits, or 3.in settlement of accounts receivable. LO 4 Compute the interest on notes receivable.

37. 8-37 Notes Receivable To the payee, the promissory note is a note receivable. To the maker, the promissory note is a note payable. LO 4 Compute the interest on notes receivable. Illustration 8-10

38. 8-38 LO 4 Compute the interest on notes receivable. Notes Receivable Note expressed in terms of  Months  Days Computing Interest Determining the Maturity Date Illustration 8-11

39. 8-39 LO 4 Compute the interest on notes receivable. Notes Receivable When counting days, omit the date the note is issued, but include the due date. Illustration 8-12 Computing Interest

40. 8-40 LO 4 Compute the interest on notes receivable. Notes Receivable Illustration: Brent Company wrote a $1,000, two-month, 8% promissory note dated May 1, to settle an open account. Prepare entry would Wilma Company makes for the receipt of the note. Notes receivable 1,000May 1 Accounts receivable 1,000 Recognizing Notes Receivable

41. 8-41 Valuing Notes Receivable Notes Receivable  Report short-term notes receivable at their cash (net) realizable value.  Estimation of cash realizable value and recording bad debt expense and related allowance are similar to accounts receivable. LO 4 Compute the interest on notes receivable.

42. 8-42 Disposing of Notes Receivable LO 5 Describe the entries to record the disposition of notes receivable. Notes Receivable 1.Notes may be held to their maturity date. 2.Maker may default and payee must make an adjustment to the account. 3.Holder speeds up conversion to cash by selling the note receivable.

43. 8-43 Honor of Notes Receivable LO 5 Describe the entries to record the disposition of notes receivable. Notes Receivable A note is honored when its maker pays it in full at its maturity date. Dishonor of Notes Receivable A dishonored note is not paid in full at maturity. Dishonored note receivable is no longer negotiable. Disposing of Notes Receivable

44. 8-44 Illustration: Wolder Co. lends Higley Inc. $10,000 on June 1, accepting a five-month, 9% interest note. If Wolder presents the note to Higley Inc. on November 1, the maturity date, Wolder’s entry to record the collection is: Honor of Notes Receivable LO 5 Describe the entries to record the disposition of notes receivable. Notes Receivable Cash 10,375Nov. 1 Notes receivable 10,000 Interest revenue 375 ($10,000 x 9% x 5/12 = $375)

45. 8-45 Accrual of Interest Receivable LO 5 Describe the entries to record the disposition of notes receivable. Notes Receivable Interest receivable 300Sept. 1 Interest revenue 300 ($10,000 x 9% x 4/12 = $ 300) Illustration 8-13 Illustration: Suppose instead that Wolder Co. prepares financial statements as of September 30. The adjusting entry by Wolder is for four months ending Sept. 30.

46. 8-46 Illustration: Prepare the entry Wolder’s would make to record the honoring of the Higley note on November 1. LO 5 Describe the entries to record the disposition of notes receivable. Notes Receivable Cash 10,375Nov. 1 Notes receivable 10,000 Interest receivable300 Interest revenue 75 Accrual of Interest

47. 8-47 Financial Statement Presentation LO 6 Explain the statement presentation of receivables. Illustration 8-14 Balance sheet presentation of receivables

48. 8-48 Managing Receivables LO 7 Describe the principles of sound accounts receivable management. Managing accounts receivable involves five steps: 1.Determine to whom to extend credit. 2.Establish a payment period. 3.Monitor collections. 4.Evaluate the liquidity of receivables. 5.Accelerate cash receipts from receivables when necessary.

49. 8-49 Managing Receivables LO 7 Describe the principles of sound accounts receivable management.  If the credit policy is too tight, you will lose sales.  If the credit policy is too loose, you may sell to customer who will pay either very late or not at all.  It is important to check references on potential new customers as well as periodically to check the financial health of continuing customers. Extending Credit

50. 8-50

51. 8-51 Managing Receivables LO 7 Describe the principles of sound accounts receivable management.  Companies should determine a required payment period and communicate that policy to their customers.  The payment period should be consistent with that of competitors. Establishing a Payment Period

52. 8-52 Managing Receivables LO 7 Describe the principles of sound accounts receivable management.  Companies should prepare an accounts receivable aging schedule at least monthly. ► Helps managers estimate the timing of future cash inflows. ► Provides information about the collection experience of the company and identifies problem accounts.  Significant concentrations of credit risk must be discussed in the notes to its financial statements. Monitoring Collections

53. 8-53 Illustration 8-16 Excerpt from Sketchers’ note on concentration of credit risk Managing Receivables LO 7 Describe the principles of sound accounts receivable management.

54. 8-54 Evaluating Liquidity of Receivables LO 8 Identify ratios to analyze a company’s receivables. Financial Statement Presentation Illustration 8-17 Data from Nike (in millions)

55. 8-55 Accounts Receivable Turnover:  Assess the liquidity of the receivables.  Measure the number of times, on average, a company collects receivables during the period. Average collection period:  Used to assess effectiveness of credit and collection policies.  Collection period should not exceed credit term period. LO 8 Identify ratios to analyze a company’s receivables. Financial Statement Presentation Evaluating Liquidity of Receivables

56. 8-56 Accelerating Cash Receipts Three reasons for the sale of receivables: 1.Size. 2.Companies may sell receivables because they may be the only reasonable source of cash. 3.Billing and collection are often time-consuming and costly. LO 9 Describe methods to accelerate the receipt of cash from receivables. Financial Statement Presentation

57. 8-57 Sale of Receivables to a Factor Illustration: Assume that Hendredon Furniture factors $600,000 of receivables to Federal Factors, Inc. Federal Factors assesses a service charge of 2% of the amount of receivables sold. LO 9 Describe methods to accelerate the receipt of cash from receivables. Financial Statement Presentation Cash 588,000 Service charge expense 12,000 Accounts receivable600,000 A factor is a finance company or bank that buys receivables from businesses for a fee and then collects the payments directly from the customers.

58. 8-58

59. 8-59 National Credit Card Sales Three parties involved when credit cards are used. 1.credit card issuer, 2.retailer, and 3.customer. LO 9 Describe methods to accelerate the receipt of cash from receivables. Financial Statement Presentation The retailer pays the credit card issuer a fee of 2% to 4% of the invoice price for its services.

60. 8-60 Illustration: Morgan Marie purchases $1,000 of compact discs for her restaurant from Sondgeroth Music Co., and she charges this amount on her Visa First Bank Card. The service fee that First Bank charges Sondgeroth Music is 3%. LO 9 Describe methods to accelerate the receipt of cash from receivables. Financial Statement Presentation Cash 970 Service charge expense 30 Sales revenue1,000 National Credit Card Sales

61. 8-61 LO 9 Describe methods to accelerate the receipt of cash from receivables. Financial Statement Presentation Illustration 8-19 Managing receivables