1. Copyright © 2007 Prentice-Hall. All rights reserved 1 ReceivablesReceivables Chapter 9

2. Copyright © 2007 Prentice-Hall. All rights reserved 2 ReceivablesReceivables Monetary Claims Arise from selling goods and services on credit and lending money Two major types –Accounts Receivable – current asset –Notes Receivable – current or long-term asset depending on when the note matures

3. Copyright © 2007 Prentice-Hall. All rights reserved 3 Objective 1 Design internal controls for receivables

4. Copyright © 2007 Prentice-Hall. All rights reserved 4 Internal Controls & Receivables Separation of cash-handling and cash- accounting duties Establish credit department –Evaluates customers for credit worthiness –Pursues collection from customers

5. Copyright © 2007 Prentice-Hall. All rights reserved 5 Receivables & Accounting Issues Balance Sheet should report receivables at the amount the company expects to collect (net realizable value) Income Statement should report the expense associated with the failure to collect (uncollectible accounts expense)

6. Copyright © 2007 Prentice-Hall. All rights reserved 6 Objective 3 Understand the direct write-off method for uncollectibles

7. Copyright © 2007 Prentice-Hall. All rights reserved 7 Direct Write-Off GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Nov9Accounts Receivable5,000 Sales5,000 Record sale on account Assume that on November 9, 2006 we sell on account, 2/10, n/30 $5,000 of merchandise. What’s the journal entry to record the sale?

8. Copyright © 2007 Prentice-Hall. All rights reserved 8 GENERAL JOURNAL DATEDESCRIPTION REF DEBITCREDIT Apr30 Uncollectible Accounts Expense 5,000 Accounts Receivable5,000 To write off a bad debt Direct Write-Off Method Assume that it is April 30 of the next year and the company has determined that it will not be able to collect on this account. Prepare the journal entry

9. Copyright © 2007 Prentice-Hall. All rights reserved 9 Direct Write-Off Method Nov 9Dec 31 End of Fiscal Year Apr 30 Sale Recorded Expense Recorded Expenses should be matched with revenues in same accounting period. Bad debts arising from 2006 sales should be treated as 2006 expenses. The direct write-off method violates the matching principle. This method is acceptable only when uncollectibles are very low

10. Copyright © 2007 Prentice-Hall. All rights reserved 10 Objective 2 Use the allowance method to account for uncollectibles

11. Copyright © 2007 Prentice-Hall. All rights reserved 11 Allowance Method Nov 9Dec 31 End of Fiscal Year Apr 30 Prepare adjusting entry based on estimates The Allowance Method has two advantages: 1. Expenses are matched with revenues in the same accounting period 2. Accounts Receivables are reported on balance sheet at the amount of cash expected to be collected

12. Copyright © 2007 Prentice-Hall. All rights reserved 12 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Dec31Uncollectible Accounts Expense Allowance for Uncollectible Accounts To estimate bad debts for period Operating expense Allowance Method Contra-asset account

13. Copyright © 2007 Prentice-Hall. All rights reserved 13 Allowance Method Accounts Receivable – reported on balance sheet at its “net realizable value” Accounts Receivable$750,000 Allowance for Doubtful Accounts(3,500) $746,500 Gross amount Estimated uncollectible Expected to be collected

14. Copyright © 2007 Prentice-Hall. All rights reserved 14 Estimating Uncollectibles Two Methods –Percent of Sales – Income Statement Approach –Aging of Accounts Receivable – Balance Sheet Approach

15. Copyright © 2007 Prentice-Hall. All rights reserved 15 Percent of Sales Method Bad debts expense = Net Credit Sales x Bad Debt %

16. Copyright © 2007 Prentice-Hall. All rights reserved 16 S9-3S9-3 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Dec31Uncollectible accounts expense7,000 Allowance for uncollectible accounts7,000 Expense = (350,000 x.02) = 7,000 When you use the percentage of sales method, you are estimating the amount of the bad debts expense. Since temporary accounts start the accounting period with a -0- balance, all you have to do is take the percentage times the revenue

17. Copyright © 2007 Prentice-Hall. All rights reserved 17 S9-3S9-3 40,000 Accounts Receivable Bal -0- Allowance for Uncollectible Accounts 7,000 Bal 7,000 Balance Sheet (partial): Accounts receivable$40,000 Less: Allowance for uncollectible accounts(7,000) Accounts receivable, net$33,000

18. Copyright © 2007 Prentice-Hall. All rights reserved 18 Aging of Accounts Receivable Method 1.Accounts receivables are grouped according to age 2.Each age group has a different likelihood of being uncollectible (the older the receivable, the less likely it will be collected) 3.Add uncollectible amounts together to compute desired balance in the Allowance for Uncollectible Accounts

19. Copyright © 2007 Prentice-Hall. All rights reserved 19 E9-17E9-17 Age of Accounts Receivable Accounts Receivable 1-30 Days31-60 Days 61-90 Days Over 90 Days $300,000$140,000$80,000$70,000$10,000 Estimated % uncollectible.5%2%6%50% Total$700$1,600$4,200$5,000 $11,500 Desired balance in Allowance for Uncollectible Accounts This method is called the balance sheet approach because you are estimating the balance that should be in the Allowance for Uncollectible Accounts after posting the adjusting entry

20. Copyright © 2007 Prentice-Hall. All rights reserved 20 E9-17E9-17 300,000 Accounts Receivable Bal 8,900 Allowance for Uncollectible Accounts 2,600 Bal 11,500 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Dec31Uncollectible accounts expense2,600 Allowance for uncollectible accounts2,600 Notice: The accounts debited and credited are the same using either the income statement approach or the balance sheet approach. It is the way the estimated amounts are computed that vary. If the desired balance is $11,500 and you already have $8,900 in the account, you need to credit the account for $2,600 more Hint: With the percentage of sales method, you do not have to worry about the balance in the allowance to determine the dollar amount in the adjusting entry. With the aging of receivables method, you do need to consider the existing balance in determining the amount

21. Copyright © 2007 Prentice-Hall. All rights reserved 21 E9-17E9-17 300,000 Accounts Receivable Bal 8,900 Allowance for Uncollectible Accounts 2,600 Bal 11,500 Balance Sheet (partial): Accounts receivable$300,000 Less: Allowance for uncollectible accounts(11,500) Accounts receivable, net$288,500

22. Copyright © 2007 Prentice-Hall. All rights reserved 22 Writing Off Uncollectible Accounts S9-7 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Jan19Allowance for Uncollectible Accounts600 Accounts Receivable - Lance Emmert600 To write off an account Under the allowance method, the expense is recognized as an adjusting entry. The balance in the Allowance account represents the amount of uncollectible receivables. When a specific account is determined to be uncollectible during the year, the allowance account needs to be reduced (debit) as does the accounts receivable (credit). This journal entry has no effect on the net receivables

23. Copyright © 2007 Prentice-Hall. All rights reserved 23 Writing Off Uncollectible Accounts S9-7 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Dec31Accounts Receivable-Lance Emmert600 Allowance for Uncollectible Accounts600 To re-instate an account already written off 31Cash600 Accounts Receivable-Lance Emmert600 To record collection on account When an account already written off is collected, reverse the first entry and then record the receipt of cash. Even though Accounts Receivable is credited in the first entry and debited for the same amount in the second entry, it is important to show in your records that the account was re-established and then paid off

24. Copyright © 2007 Prentice-Hall. All rights reserved 24 Credit Card, Bankcard, Debit-Card Sales One way to avoid risk of Bad Debts is to accept credit cards like Visa or American Express. The credit card company charges the retailer a fee (between 1 and 5% of the charge). Bank credit cards are deposited in bank like cash. Record a debit to cash and Bankcard Discount Expense and credit Sales Revenue Other credit cards receipts, like Discover and American Express, must be debited to Accounts Receivable until the cash is actually collected. Debit-Card Sales: Just like a cash transaction, no discount expense.

25. Copyright © 2007 Prentice-Hall. All rights reserved 25 S9-8S9-8 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Account Receivable-American Express9,800 Credit-Card Discount Expense200 Sales Revenue10,000 Cash7,880 Bankcard Discount Expense120 Sales Revenue8,000

26. Copyright © 2007 Prentice-Hall. All rights reserved 26 Objective 4 Account for notes receivable

27. Copyright © 2007 Prentice-Hall. All rights reserved 27 Notes Receivable A note is a written promise to pay a specific amount at a specific future date Interest - price paid by a borrower for using a lender’s money

28. Copyright © 2007 Prentice-Hall. All rights reserved 28 PROMISSORY NOTE ______________ _____________ Amount Date For value received, I promise to pay to the order of First National Bank __________________________________ Dollars on ______________________________ plus interest at the annual rate of 12%. ________________________ PROMISSORY NOTE ______________ _____________ Amount Date For value received, I promise to pay to the order of First National Bank __________________________________ Dollars on ______________________________ plus interest at the annual rate of 12%. ________________________ Notes Receivable $10,000.00 Ten thousand and no/100--------------------- Oct. 4, 2007 January 2, 2008 Jeanette Sims Principal Payee Interest starts Maker Maturity Date Interest Rate

29. Copyright © 2007 Prentice-Hall. All rights reserved 29 Maturity Value Principal + Interest due at maturity

30. Copyright © 2007 Prentice-Hall. All rights reserved 30 Identifying Maturity Date Stated in terms of months - maturity date is determined by counting the months from the date of issue, and falls on same day of the month as date the note was issued Stated in terms of days - maturity date is determined by counting the days from the date of issue (do not count the day on which the note is dated, but do count the day on which it comes due)

31. Copyright © 2007 Prentice-Hall. All rights reserved 31 Determine the Maturity Date A 60-day note dated Oct 4, 2006 is issued. Determine the due date: Number of days on note60 Days in October31 Date of note4 Days outstanding in October27 Days remaining on note33 Days in November30 December due date3

32. Copyright © 2007 Prentice-Hall. All rights reserved 32 If the note is expressed in days, base a year on 360 days. Computing Interest Interest = Principal x Interest Rate x Time If the note is expressed in months, base a year on 12 months Remember, the interest rate is an annual rate. If you take Principal x Interest rate, you compute the amount of interest on a one year note. This is why you must multiply by the time the note is outstanding

33. Copyright © 2007 Prentice-Hall. All rights reserved 33 S9-9S9-9 Note 1: $50,000 x 10% x 3/12 = $1,250 Note 2: $10,000 x 9% x 60/360 = $150 Note 3: $15,000 x 12% x 75/360 = $375 Note 4: $100,000 x 8% x 6/12 = $4,000

34. Copyright © 2007 Prentice-Hall. All rights reserved 34 Accounting for Notes Receivable S9-10 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT May6Note Receivable-B Milam100,000 Cash100,000 Aug4Cash Interest Revenue2,500 Note Receivable-B Milam100,000 First – what is the due date? Number of days on note90 Days in May31 Date of note6 Days outstanding in May25 Days remaining on note65 Days in June30 35 Days in July31 Due date in August4 Next – what is the amount of interest on this note? 100,000 x.1 x 90/360 = 2,500

35. Copyright © 2007 Prentice-Hall. All rights reserved 35 Accruing Interest Revenue Date of Note, Aug 1, 2008 End of Fiscal Year, Dec 31, 2008 Maturity Date, Aug 1, 2009 Prepare adjusting entry to record interest earned in 20X8 In the previous example, the note was created and matured within the same accounting period. In E9-8, the note spans two accounting periods. When a note spans two accounting periods, you need to allocate some of the interest to each period. In this example, 5 months’ interest would be accrued for 2008 (Aug 1-Dec 31). The other 7 months’ of interest would be recognized in 2009

36. Copyright © 2007 Prentice-Hall. All rights reserved 36 E9-8E9-8 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT 2008 Feb12Bankcard Discount Expense2,000 Cash98,000 Sales100,000 Aug1Notes Receivable – J Porter20,000 Cash20,000 Dec31Interest Receivable1,000 Interest Revenue1,000 (20,000 x.12 x 5/12)

37. Copyright © 2007 Prentice-Hall. All rights reserved 37 E9-8E9-8 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT 2009 Aug1Cash22,400 Interest Receivable1,000 Interest Revenue1,400 Note Receivable – J Porter20,000 Interest revenue = 20,000 x.12 x 7/12 Eliminate balance carried forward from last year now that you have actually received the interest payment

38. Copyright © 2007 Prentice-Hall. All rights reserved 38 Dishonored Notes Receivable GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Accounts Receivable10,100 Interest Revenue100 Note Receivable 10,000 When a maker of the note defaults on the note, the maturity value of the note receivable is transferred to accounts receivable because the note has expired

39. Copyright © 2007 Prentice-Hall. All rights reserved 39 Objective 5 Report receivables on the balance sheet

40. Copyright © 2007 Prentice-Hall. All rights reserved 40 Reporting Receivables Two approaches: Accounts receivable$5,000 Less: Allowance for uncollectible accounts(500) Accounts receivable, net$4,500 Or Accounts receivable, net of allowance for uncollectible accounts of $500$4,500

41. Copyright © 2007 Prentice-Hall. All rights reserved 41 Objective 6 Use the acid-test ratio and days’ sales in receivables to evaluate a company

42. Copyright © 2007 Prentice-Hall. All rights reserved 42 (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities Acid-Test Ratio Also called the “quick ratio” Stringent measure of liquidity Measures entity’s ability to pay its current liabilities immediately

43. Copyright © 2007 Prentice-Hall. All rights reserved 43 E9-23 (a) (Cash + Short-term investments + Net current receivables) ÷ Total current liabilities For 20X8: (10,000 + 11,000 + 68,000) ÷ 107,000 =.83 For 20X9: (3,000 + 23,000 + 53,000) ÷ 104,000 =.76 The acid-test ratio is not as good in 2009 as it was in 2008. Cherokee’s acid-test ratio for 2009 is slightly lower than the industry average of.80

44. Copyright © 2007 Prentice-Hall. All rights reserved 44 Days’ Sales in Receivables Also called “collection period” How many days does it take to collect the average level of receivables?

45. Copyright © 2007 Prentice-Hall. All rights reserved 45 One day’s sales = Net sales ÷ 365 days Days’ sales in average accounts receivable = Average net accounts receivable ÷ One day’s sales Days’ Sales in Receivables Average net A/R = (Beginning net receivables + Ending net receivables)/2

46. Copyright © 2007 Prentice-Hall. All rights reserved 46 One day’s sales = 600,060 ÷ 365 days = $1,644 Days’ sales in average accounts receivable = ((42,800 + 38,200)/2) ÷ 1,644 = 40,500 / 1,644 = 24.6 days E9-24E9-24 Answer to part 2: Swiftmedia’s collection period of 25 days is a little shorter than the company’s normal credit terms of 30 days. This is good for the company because it means the company receives cash quickly and can put its cash to work with little delay

47. Copyright © 2007 Prentice-Hall. All rights reserved 47 End of Chapter 9