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Accounting for Receivables INTERMEDIATE ACCOUNTING I CHAPTER 7.

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Presentation on theme: "Accounting for Receivables INTERMEDIATE ACCOUNTING I CHAPTER 7."— Presentation transcript:

1 Accounting for Receivables INTERMEDIATE ACCOUNTING I CHAPTER 7

2 Recognition Depends on the earnings process; for most credit sales, revenue and the related receivables are recognized at the point of delivery. Initial valuation Initially recorded at the exchange price agreed upon by the buyer and seller. Subsequent valuation Initial valuation reduced to net realizable value by: 1. Allowance for sales returns 2. Allowance for uncollectible accounts: - The income statement approach - The balance sheet approach Classification Almost always classified as a current asset. Measuring and Reporting Accounts Receivable

3 CASH DISCOUNTS Cash discounts reduce the amount to be paid if remittance is made within a specified short period of time. Gross method – records the sale at the gross price (no discount) and the discount is taken only if the receivable is paid within the discount period. Net method – records the sale at the net price (taking out the discount). If the receivable is paid within the discount period, no additional adjustments are required. If the customer does not pay the bill within the discount period, the difference in the amount received and the amount paid is considered interest revenue.

4 CASH DISCOUNTS – Example 1 October 5, 2013 Accounts Receivable20,000 Sales20,000 Gross Method October 14, 2013 Cash13,720 Sales Discounts (14,000 X.02) 280 Accounts Receivable 14,000 November 4, 2013 Cash6,000 Accounts Receivable 6,000 The Hawthorne Manufacturing Company offers credit customers a 2% cash discount if the sales price is paid within 10 days. Any amounts not paid within 10 days are due in 30 days. These repayment terms are stated as 2/10, n/30. On October 5, 2013, Hawthorne sold merchandise at a price of $20,000. The customer paid $13,720 ($14,000 less the 2% cash discount) on October 14 and the remaining balance of $6,000 on November 4. Draft the appropriate journal entries to record the sale and cash collection, using the gross method.

5 CASH DISCOUNTS – Example 2 October 5, 2013 Accounts Receivable (20,000 – 400*) 19,600 Sales19,600 Net Method October 14, 2013 Cash13,720 Accounts Receivable 13,720 November 4, 2013 Cash6,000 Accounts Receivable 5,880 Interest Revenue 120 The Hawthorne Manufacturing Company offers credit customers a 2% cash discount if the sales price is paid within 10 days. Any amounts not paid within 10 days are due in 30 days. These repayment terms are stated as 2/10, n/30. On October 5, 2013, Hawthorne sold merchandise at a price of $20,000. The customer paid $13,720 ($14,000 less the 2% cash discount) on October 14 and the remaining balance of $6,000 on November 4. Draft the appropriate journal entries to record the sale and cash collection, using the net method.

6 Accounts Receivable should be reported on the balance sheet under Current Assets at their net realizable value. Possible returns and customer nonpayment could cause subsequent accounts receivable to be less than initial valuation. VALUING ACCOUNTS RECEIVABLE

7 Uncollectible accounts (or bad debts) must be accounted for in companies who offer credit. Two methods exist for accounting for uncollectible accounts: Direct Write-off Method Allowance Method o Income Statement Approach (estimate is a percentage of sales) o Balance Sheet Approach (estimate is a percentage of accounts receivable adjusted for previous estimates) If the estimate for bad debts is material, the allowance method should be used. The allowance method adheres to the Matching Principle by attempting to estimate future bad debts and match them with the related sales revenue in the current accounting period. UNCOLLECTIBLE ACCOUNTS

8 The Hawthorne Manufacturing Company sells its products offering 30 days credit to its customers. During 2013, its first year of operations, the following events occurred: Sales on credit$1,200,000 Cash collections from credit customers 895,000 Accounts receivable, end of year$ 305,000 Assume an aging of accounts receivable revealed a required allowance of $25,500, and the allowance account prior to the adjusting entry was a credit balance of $4,000: Prepare the journal entry to record the adjustment for uncollectible accounts using the Income Statement Approach. UNCOLLECTIBLE ACCOUNTS: Allowance Method – Income Statement Approach Bad debt expense24,000 Allowance for uncollectible accounts24,000 (2% x $1,200,000)

9 The Hawthorne Manufacturing Company sells its products offering 30 days credit to its customers. During 2013, its first year of operations, the following events occurred: Sales on credit$1,200,000 Cash collections from credit customers 895,000 Accounts receivable, end of year$ 305,000 Allowance for Uncollectible Accounts$4,000(credit) Assume that 8% of ending accounts receivable are estimated to be uncollectible. Prepare the journal entry to record the adjustment for uncollectible accounts. UNCOLLECTIBLE ACCOUNTS: Allowance Method – Balance Sheet Approach Bad debt expense20,400 Allowance for uncollectible accounts20,400 Calculation: Desired Balance: $305,000 X.08 = $24,400 Desired Balance$24,400 Less: Credit balance in Allowance account (4,000) Amount of Adjustment$20,400

10 Allowance for uncollectible accounts is a contra account (valuation account) to accounts receivable. In the 2013 balance sheet in the current asset section, accounts receivable would be reported net of the allowance, as follows: Accounts receivable$305,000 Less: Allowance for uncollectible accounts (24,000) Net accounts receivable$281,000 Balance Sheet Presentation

11 Return of merchandise by a customer is recorded by debiting Sales Returns & Allowances (a contra-revenue account) and crediting Accounts receivable (to reduce the amount owed by the customer.) The returned merchandise must also be accounted for by debiting Inventory and crediting Cost of Goods Sold. If material, sales returns should be anticipated by subtracting an allowance for estimated returns from accounts receivable. The adjustment for sales returns is reduced by the actual returns made during the fiscal year. SALES RETURNS

12 During 2013, its first year of operations, the Hawthorne Manufacturing Company sold merchandise on account for $2,000,000. This merchandise cost $1,200,000 (60% of the selling price). Customers returned $130,000 in sales during 2013, prior to making payment. Draft the entries to record sales and merchandise returned during the year, assuming that a perpetual inventory system is used. SALES RETURNS Example – Part 1 Sales Accounts Receivable2,000,000 Sales2,000,000 Cost of Goods Sold ($2,000,000 X 60%) 1,200,000 Inventory1,200,000 Returns Sales returns (actual returns) 130,000 Accounts Receivable130,000 Inventory ($130,000 X 60%) 78,000 Cost of Goods Sold78,000

13 Hawthorne Manufacturing Company estimates that 10% of all sales will be returned. Assuming this is a material amount, draft the entries to record the adjustment at the end of the fiscal period. SALES RETURNS Example – Part 2 Sales Returns ([$2,000,000 X 10%]-$130,000 70,000 Allowance for Sales Returns70,000 Inventory-Estimated Returns42,000 Cost of Goods Sold ($70,000 X 60%) 42,000

14 WHEN ACCOUNTS ARE DEEMED UNCOLLECTIBLE The actual write-off of a receivable using the allowance method is recorded as a debit to the allowance account and a credit to accounts receivable. Assume that actual bad debts in 2014 were $25,000. Draft the journal entry to record the write-off.

15 Allowance for uncollectible accounts25,000 Accounts receivable25,000 Net realizable value is not directly affected by the write-offs. Accounts receivable$280,000 Less: Allowance for uncollectible accounts (500) Net accounts receivable$279,500

16 When Previously Written-off Accounts Are Collected Assume a $1,200 account that was previously written off is collected. The following journal entries record the event: Accounts receivable1,200 Allowance for uncollectible accounts1,200 Cash1,200 Accounts receivable1,200

17 NOTES RECEIVABLE Notes Receivable are formal credit arrangements between a creditor and a debtor. Notes can be issued for cash, merchandise, or other assets. Payment of the face amount of the note, or principal, is due at a specified maturity date. INTEREST-BEARING NOTES RECEIVABLE The typical Note Receivable is an interest-bearing note. Interest is calculated on the face amount of the note based on a stated interest rate.

18 INTEREST-BEARING NOTES RECEIVABLE The Stridewell Wholesale Shoe Company manufactures athletic shoes that it sells to retailers. On May 1, 2013, the company sold shoes to Harmon Sporting Goods. Stridewell agreed to accept a $700,000, 6-month, 12% note in payment for the shoes. Interest is payable at maturity. Stridewell would account for the note as follows: To record the sale of goods in exchange for a note receivable. May 1, 2013 Notes receivable700,000 Sales revenue700,000 To record the collection of the note at maturity. November 1, 2013 Cash ($700, ,000) 742,000 Interest revenue ($700,000 x 12% x 6/12) 42,000 Notes receivable700,000

19 If the sale in the above illustration occurs on August 1, 2013, and the company's fiscal year-end is December 31, a year-end adjusting entry accrues interest earned. December 31, 2013 Interest receivable35,000 Interest revenue ($700,000 x 12% x 5/12) 35,000 The February 1 collection is then recorded as follows: February 1, 2014 Cash [$700,000 + ($700,000 x 12% x 6/12)] 742,000 Interest revenue ($700,000 x 12% x 1/12) 7,000 Interest receivable (accrued at December 31) 35,000 Note receivable 700,000

20 NONINTEREST-BEARING NOTES Sometimes a receivable assumes the form of a so-called noninterest-bearing note. Noninterest-bearing notes actually do bear interest, but the interest is deducted at the onset (or discounted) from the face amount to determine the cash proceeds made available to the borrower. When interest is discounted from the face amount of a note, the effective interest rate is higher than the stated discount rate. Similar to accounts receivable, if a company anticipates bad debts on short-term notes receivable, it uses an allowance account to reduce the receivable to net realizable value. The Discount on Note Receivable account is contra to the Note Receivable account.

21 NONINTEREST-BEARING NOTES The preceding note could be packaged as a $700,000 noninterest-bearing note, with a 12% discount rate. May 1, 2013 Note receivable (face amount) 700,000 Discount on note receivable ($700,000 x 12% x 6/12) 42,000 Sales revenue (difference) 658,000 November 1, 2013 Discount on note receivable 42,000 Interest revenue 42,000 Cash 700,000 Note receivable (face amount) 700,000

22 CALCULATING THE EFFECTIVE INTEREST RATE When interest is discounted from the face amount of a note, the effective interest rate is higher than the stated discount rate. Annual Interest at Stated Rate/Sales Price = Effective Annual Interest Rate $84,000*/$658,000 = Stated as a percent rounded to two decimal places = % * $700,000 X.12 = $84,000

23 If the sale occurs on August 1, the December 31, 2013, adjusting entry and the entry to record the cash collection on February 1, 2014, are recorded as follows: December 31, 2013 Discount on note receivable 35,000 Interest revenue ($700,000 x 12% x 5/12) 35,000 February 1, 2014 Discount on note receivable 7,000 Interest revenue ($700,000 x 12% x 1/12) 7,000 Cash 700,000 Note receivable (face amount) 700,000 ACCRUAL OF INTEREST

24 The transfer of a note receivable to a financial institution is called discounting. When a note is discounted to a financial institution, the seller receives cash in exchange for the note. The proceeds from the sale are calculated as the maturity value of the note less the financial institution’s discount rate. DISCOUNTING A NOTE RECEIVABLE

25 DISCOUNTING A NOTE RECEIVABLE - Example Discounted Note Treated as a Sale On December 31, 2013, the Stridewell Wholesale Shoe Company sold land in exchange for a nine-month, 10% note. The note requires the payment of $200,000 plus interest on September 30, The company’s fiscal year- end is December 31. The 10% rate properly reflects the time value of money for this type of note. On March 31, 2014, Stridewell discounted the note at the Bank of the East. The Bank’s discount rate is 12%. Because the note has been outstanding for three months before being discounted at the bank, Stridewell first records the interest that has accrued prior to being discounted: March 31, 2014 Interest receivable5,000 Interest revenue ($200,000 x 10% x 3/12) 5,000

26 DISCOUNTING A NOTE RECEIVABLE (continued) Next, the value of the note if held to maturity is calculated. Then the discount for the time remaining to maturity is deducted to determine the cash proceeds from discounting the note: $200,000 Face amount 15,000Interest to maturity ($200,000 x 10% x 9/12) 215,000Maturity value (12,900)Discount ($215,000 x 12% x 6/12) $202,100Cash proceeds Cash (proceeds determined above) 202,100 Loss on sale of note receivable (difference) 2,900 Note receivable (face amount) 200,000 Interest receivable (accrued interest determined above) 5,000


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