1. Accounts Receivable and Accounts Payable Module 5

2. SAP 2007 / SAP University Alliances Introductory Accounting Learning Objectives Explain Accounts Receivable. Describe and illustrate entries for the recording of Accounts Receivable. Illustrate and practice allowance methods to value Accounts Receivable. Illustrate and practice estimation methods to value Accounts Receivable. Percent of sales Percent of Accounts Receivable Illustrate and practice the Direct write off method. Describe accounting for short term Notes Receivables. Discuss converting Short Term notes to cash before maturity Discuss AR Turnover and Days Sales uncollected Ratios. Explain Accounts Payable. Describe classification of Liabilities. Run an SAP demonstration. Practice making receivable and payable entries in SAP.

3. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Receivable Arise from credit sales to customers. Often referred to as Trade Receivables. Other receivables include interest receivable, rent receivable, tax refund receivable.

4. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Receivable Companies selling on account need to: Maintain a separate account for each customer. Account for bad debts.

5. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Receivable Example: Sample has the following Accounts Receivable balances at June 30: General Ledger A/R Subledger Accounts Receivable Jones Co bal. 5,000bal. 2,000 Store ABC bal. 3,000 Total 5,000 Control account balances with total of subledger balances.

6. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Receivable Example: Credit sale for $550 Accounts Receivable- Store ABC 550 Sales 550 General Ledger A/R Subledger Accounts Receivable Jones Co bal. 5,000bal. 2,000 550 bal. 5,550 Store ABC bal. 3,000 550 bal. 3,550 Total 5,550 Control account balances with total of subledger balances.

7. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Receivable Example: Collection of account Cash 850 Accounts Receivable-Jones Co 850 General Ledger A/R Subledger Accounts Receivable Jones Co bal. 5,000bal. 2,000 850 550 850 bal. 1,150 bal. 4,700 Store ABC bal. 3,000 550 bal. 3,550 Total 4,700 Control account balances with total of subledger balances.

8. SAP 2007 / SAP University Alliances Introductory Accounting Non-Bank Credit Cards Retailers often accept non-bank credit cards. The retailers mail the receipts and await payment from the credit card company. These companies charge the retailer a fee and deduct it from the amount owing.

9. SAP 2007 / SAP University Alliances Introductory Accounting Valuing Accounts Receivable Some customers who are granted credit do not pay what they promised. The accounts of these customers are called uncollectible accounts or bad debts.

10. SAP 2007 / SAP University Alliances Introductory Accounting Valuing Accounts Receivable Methods for accounting for uncollectible accounts: Allowance method (satisfies GAAP) Direct method (does not satisfy GAAP)

11. SAP 2007 / SAP University Alliances Introductory Accounting Allowance Method Satisfies matching principle by matching expected bad debts losses (expenses) with revenues that produced the losses. Adjustments for bad debts are made at the end of the accounting period. Adjustments use a contra-asset account called Allowance for Doubtful Accounts.

12. SAP 2007 / SAP University Alliances Introductory Accounting Example: The estimated bad debts for Jones Co is $1,000. The period end entry to record bad debts is: Bad Debts Expense1,000 Allowance for Doubtful Accounts 1,000 An allowance account is used since we do not know which accounts will be uncollectible. Recording Estimated Bad Debt Expense — Allowance Method

13. SAP 2007 / SAP University Alliances Introductory Accounting Example: A specific customer’s account (Ron Trent) is considered uncollectible. The entry to record the write-off is: Allowance for Doubtful Accounts880 Accounts Receivable — Ron Trent 880 Note that there is no expense recorded when the account is written off. The estimated expense was previously recorded. Writing Off a Bad Debt — Allowance Method

14. SAP 2007 / SAP University Alliances Introductory Accounting General Ledger Balances Bad Debts Expense 1,000 Allowance for Doubtful Accounts 1,000 To record estimated bad debts Allowance for Doubtful Accounts 880 Accounts Receivable — Ron Trent 880 To write off an uncollectible account Accounts ReceivableAllow. For Doubtful Accts. bal. 18,000 1,000 880 880 bal. 17,120bal. 120

15. SAP 2007 / SAP University Alliances Introductory Accounting Realizable Value Before and After Write-off Before Write-off After Write-off Accounts Receivable$18,000$17,120 Less: Allowance for Doubtful Accounts1,000120 Est. Realizable Accounts Receivable$17,000 Accounts ReceivableAllow. For Doubtful Accts. bal. 18,000 1,000 880 880 bal. 17,120bal. 120

16. SAP 2007 / SAP University Alliances Introductory Accounting Example: Ron Trent pays his account in full after the account had been written off. Entries are needed to record the reinstatement of the account and the subsequent collection. The entries are: Accounts Receivable-Ron Trent 880 Allowance for Doubtful Accounts 880 To reinstate customer’s account. Cash 880 Accounts Receivable-Ron Trent 880 To record collection of account. Recovery of a Bad Debt- Allowance Method

17. SAP 2007 / SAP University Alliances Introductory Accounting Estimating Bad Debt Expense Acceptable Methods: - Percent of Sales Approach - Accounts Receivable Approach

18. SAP 2007 / SAP University Alliances Introductory Accounting Percent of Sales Approach Also referred to as the Income Statement Approach. Based on idea that a percentage of a company’s sales are uncollectible. The primary focus is on estimating bad debts expense for the income statement.

19. SAP 2007 / SAP University Alliances Introductory Accounting Percent of Sales Approach Under this approach, bad debts expense is computed as follows: Current Period Credit Sales x Estimated Bad Debt % = Estimated Bad Debts Expense

20. SAP 2007 / SAP University Alliances Introductory Accounting Example: BCD Company has sales of $500,000 and estimates 0.5% of those sales will not be collectible. Estimated Bad Debts Expense is calculated as $2,500 ($500,000 x.5%). The period end adjusting entry would be: Percent of Sales Approach Bad Debts Expense 2,500 Allowance for Doubtful Accounts 2,500 To record estimated bad debts

21. SAP 2007 / SAP University Alliances Introductory Accounting This method assumes that a percentage of Accounts Receivable is uncollectible. Using this method, we compute the estimate of the Allowance for Doubtful Accounts as: Year-end Accounts Receivable x Bad Debt % Percent of Accounts Receivable Approach

22. SAP 2007 / SAP University Alliances Introductory Accounting Percent of Accounts Receivable Approach Bad Debts Expense is computed as: Estimated adjusted balance in Allowance for Doubtful Accounts - Unadjusted year-end balance in Allowance for Doubtful Accounts = Estimated Bad Debts Expense The objective for the entry is to make the Allowance account balance equal to the portion of outstanding Accounts Receivable estimated to be uncollectible.

23. SAP 2007 / SAP University Alliances Introductory Accounting Assumes that the older the Account Receivable the more likely is will become uncollectible. Steps: 1. Group accounts based on how much time has passed since they were created. 2. Estimate rates of uncollectibility for each group. 3. Apply rate to each group to get the required balance for the Allowance account. Aging of Accounts Receivable Approach

24. SAP 2007 / SAP University Alliances Introductory Accounting Example: At December 31, the receivables for ABC Co were classified as follows: Aging of Accounts Receivable

25. SAP 2007 / SAP University Alliances Introductory Accounting Using estimated bad debt percentages, ABC Co would calculate the estimated uncollectible amount as follows: Aging of Accounts Receivable

26. SAP 2007 / SAP University Alliances Introductory Accounting ABC Co’s unadjusted balance in the allowance account is a debit of $700. The previous computation shows the desired balance is $2,350; therefore, the adjusting entry is for $2,350 + 700 = $3,050. Aging of Accounts Receivable Bad Debts Expense 3,050 Allowance for Doubtful Accounts 3,050 To record estimated bad debts Allowance for Doubtful Accounts Unadj. bal. 700 3,050 Adj. bal. 2,350

27. SAP 2007 / SAP University Alliances Introductory Accounting Direct Write-off Method Sometimes used as an alternative to the Allowance method when uncollectible accounts are not material. The loss from an uncollectible account is recorded when it is determined to be uncollectible. This method does not satisfy the principles of matching and conservatism.

28. SAP 2007 / SAP University Alliances Introductory Accounting Example: A specific customer’s account (Ron Trent) is considered uncollectible. The entry to record the write-off is: Bad Debts Expense 450 Accounts Receivable—Ron Trent 450 Writing Off a Bad Debt — Direct Write-off Method

29. SAP 2007 / SAP University Alliances Introductory Accounting Short-Term Notes Receivable Promissory Note A written promise to pay a specified amount of money either on demand or at a definite future date. Short-Term Note Receivable A promissory note that becomes due within 12 months or within the firm’s operating cycle.

30. SAP 2007 / SAP University Alliances Introductory Accounting Usually interest bearing.Interest rates are stated on an annual basis.Interest is calculated as follows: Interest = Principal of the note Annual interest rate Time expressed in years XX Short-Term Notes Receivable

31. SAP 2007 / SAP University Alliances Introductory Accounting Short-Term Notes Receivable Example: Sample Co receives a $2,000, 90-day, 10% promissory note at the time of a sale. The entry to record the transaction would be: Notes Receivable 2,000 Sales 2,000

32. SAP 2007 / SAP University Alliances Introductory Accounting Short-Term Notes Receivable Example: On December 1, Sample Co receives a $5,000, 60-day, 10% promissory note and $1,000 cash to settle a $6,000 past-due account. The entry to record the transaction would be: Cash 1,000 Notes Receivable 5,000 Accounts Receivable 6,000

33. SAP 2007 / SAP University Alliances Introductory Accounting Short-Term Notes Receivable On December 31, 30 days after the note is issued, an accrual for interest earned on the note is made. The entry to record the accrual would be: Interest Receivable 41.10 Interest Revenue 41.10 (5,000 x 10% x 30/365) On January 30, the 60-day note matures. The entry to record the honouring of the note would be: Cash 5,082.20 Interest Revenue 41.10 Interest Receivable 41.10 Notes Receivable 5,000.00 (5,000 x 10% x 60/365)= 82.20

34. SAP 2007 / SAP University Alliances Introductory Accounting Converting Receivables to Cash Before Maturity Receivables are sometimes converted into cash before maturity since: Companies may need the cash. Companies do not want to be involved in the collection activities.

35. SAP 2007 / SAP University Alliances Introductory Accounting Converting Receivables to Cash Before Maturity Conversion of receivables into cash is accomplished by either: Selling them to a factor Pledging them as loan security.

36. SAP 2007 / SAP University Alliances Introductory Accounting Ratios The quality (likelihood of collection) and liquidity (speed of collection) of a company’s receivables may be assessed by calculating: 1. Accounts receivable turnover ratio 2. Days’ sales uncollected

37. SAP 2007 / SAP University Alliances Introductory Accounting Ratios Accounts receivable turnover = Net Credit Sales Average accounts receivable Days’ sales Uncollected = Average accounts receivable Net sales x 365

38. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Payable

39. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Payable Arise from credit purchases from vendorsOften referred to as Trade Payables. Companies buying on account need to Maintain a separate account for each vendor.

40. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Payable Example: Sample has the following Accounts Payable balances at March 30: General Ledger A/P Subledger Accounts Payable Jones Co bal. 5,000 bal. 2,000 Store ABC bal. 3,000 Total 5,000 Control account balances with total of subledger balances.

41. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Payable Example: Credit purchase for $550. Purchases 550 Accounts payable - Store ABC 550 General Ledger A/P Subledger Accounts Payable Jones Co bal. 5,000 bal. 2,000 550 bal. 5,550 Store ABC bal. 3,000 550 bal. 3,550 Total 5,550 Control account balances with total of subledger balances.

42. SAP 2007 / SAP University Alliances Introductory Accounting Accounts Payable Example: Payment on account Accounts Payable - Jones Co 850 Cash 850 General Ledger A/R Subledger Accounts Payable Jones Co bal. 5,000 bal. 2,000 850 550 850 bal. 1,150 bal. 4,700 Store ABC bal. 3,000 550 bal. 3,550 Total 4,700 Control account balances with total of subledger balances.

43. SAP 2007 / SAP University Alliances Introductory Accounting Liabilities A future payment of assets or services that a company is presently obligated to make as a result of past transactions or events. Present obligation to make a future payment.Result from past transactions.May be classified as current or long-term.

44. SAP 2007 / SAP University Alliances Introductory Accounting Current Liabilities Are due within one year or within the next operating cycle, whichever is longer. Are settled using current assets or by creating other current liabilities. Current vs. Long-Term Liabilities Long-Term Liabilities Do not require payment within the longer of one year or an operating cycle.

45. SAP 2007 / SAP University Alliances Introductory Accounting Current vs. Long-Term Liabilities 1 year or operating cycle Balance sheet date Current liabilityLong-term liability Accounts payable Unearned revenues Wages payable Current portion of notes payable Bonds payable Lease obligations Long-term portion of notes payable Examples:

46. SAP 2007 / SAP University Alliances Introductory Accounting Are obligations that have little uncertainty and are set by agreements, contracts, or laws. Known (Determinable) Liabilities Examples: Accounts payable Unearned revenues Payroll taxes Sales taxes Notes payable

47. SAP 2007 / SAP University Alliances Introductory Accounting A current obligation in the form of a written promissory note. May be issued: To replace an account payable When obtaining a bank loan To purchase merchandise or other assets Short-Term Notes Payable

48. SAP 2007 / SAP University Alliances Introductory Accounting On November 30, a note is used to replace a $5,000 overdue account payable that does not bear interest. The customer agrees to pay $1,000 cash and sign a 60-day, 10% note to replace the account payable. The customer’s entry to record this transaction would be: Accounts payable5,000 Cash1,000 Notes payable4,000 Short-Term Notes Payable: Example

49. SAP 2007 / SAP University Alliances Introductory Accounting On December 31, the customer’s year end, an interest accrual is made. The customer’s entry to record this accrual would be: Interest expense33.97 Interest payable33.97 $4,000 x 10% x 31/365

50. SAP 2007 / SAP University Alliances Introductory Accounting On January 30, the note’s due date, the note and interest is paid in full. The customer’s entry to record this would be: Notes payable4,000.00 Interest payable 33.97 Interest expense 31.78 Cash 4,065.75 $4,000 x 10% x 29/365 = $37.78