1. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 8 Reporting and Interpreting Receivables, Bad Debt Expense, and Interest Revenue

2. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Accounts Receivable Amounts owed by other companies or persons for cash, goods, or services. Open accounts owed to the business by trade customers.

3. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Notes Receivable A note receivable is a written contract establishing the terms by which a company will receive amounts it is owed. Companies may convert accounts receivable balances to notes for customers who are having difficulty paying their receivables.

4. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin $1,200 January 5, 2008 Sixty days after date I promise to pay to the order of Skechers U.S.A., Inc. One thousand two hundred ---------------------------------Dollars Payable at First National Bank Value received with interest at per annum No. Due Jones Athletic Company 8563March 6, 2008 8% Alan Jones Notes Receivable Due Date Interest Rate Term Payee Principal

5. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 1 Describe the tradeoffs of extending credit.

6. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Extending credit is likely to increase sales, but not without costs: Increased wage costs to manage receivables Bad debts costs Delayed receipt of cash Businesses extend credit to generate additional sales and to meet the terms offered by competitors. Pros and Cons of Extending Credit

7. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 2 Estimate and report the effects of uncollectible accounts.

8. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Accounts Receivable and Bad Debts Bad debts result from credit customers who will not pay the business the amount they owe, regardless of collection efforts.

9. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Bad debts are likely to be discovered in periods after the credit sale. If bad debts are not reported until discovered, income is distorted in the periods of sale as well as in the period of bad debt discovery. Bad debts are likely to be discovered in periods after the credit sale. If bad debts are not reported until discovered, income is distorted in the periods of sale as well as in the period of bad debt discovery. Accounts Receivable and Bad Debts

10. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Bad Debt Expense Sales Revenue Record in same accounting period. Matching Principle The Allowance Method of Accounting for Bad Debts

11. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Most businesses record an estimate of the bad debt expense with an adjusting entry at the end of the accounting period. The Allowance Method of Accounting for Bad Debts

12. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Record Estimated Bad Debt Expense For the year ended December 31, 2005, Skechers U.S.A., Inc., estimated its bad debt expense to be $2,882,000. Prepare the adjusting entry.

13. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Bad Debt Expense is normally classified as a selling expense and is closed at year-end. Contra asset account Record Estimated Bad Debt Expense For the year ended December 31, 2005, Skechers U.S.A., Inc., estimated its bad debt expense to be $2,882,000. Prepare the adjusting entry.

14. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Allowance for Doubtful Accounts Amount the business expects to collect. Balance Sheet Disclosure

15. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Remove (Write Off) Specific Customer Balances When it is clear that a specific customer’s account receivable will be uncollectible, the amount should be removed from the Accounts Receivable account and charged to the Allowance for Doubtful Accounts.

16. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Remove (Write Off) Specific Customer Balances Skechers’ total write-offs for 2005 were $1,729,000. Prepare a summary journal entry for these write-offs.

17. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Remove (Write Off) Specific Customer Balances Skechers’ total write-offs for 2005 were $1,729,000. Prepare a summary journal entry for these write-offs.

18. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Assume that before the write-off, Skechers’ Accounts Receivable balance was $56,000,000 and the Allowance for Doubtful Accounts balance was $6,043,000. Let’s see what effect the total write-offs of $1,729,000 had on these accounts. Assume that before the write-off, Skechers’ Accounts Receivable balance was $56,000,000 and the Allowance for Doubtful Accounts balance was $6,043,000. Let’s see what effect the total write-offs of $1,729,000 had on these accounts. Remove (Write Off) Specific Customer Balances

19. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Notice that the total write-offs of $1,729,000 did not change the net accounts receivable value nor did it affect any income statement accounts. Remove (Write Off) Specific Customer Balances

20. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Estimating Bad Debts Aging of Accounts Receivable ???? Focus is on determining the desired balance in the Allowance for Doubtful Accounts on the balance sheet.

21. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Aging Schedule Each customer’s account is aged by separating the total amount owed by each customer into aging categories based on the number of days that have passed since uncollected amounts were first recorded in the account. Let’s look on the next slide to see an aging of accounts receivable for Skechers (all amounts in thousands). Each customer’s account is aged by separating the total amount owed by each customer into aging categories based on the number of days that have passed since uncollected amounts were first recorded in the account. Let’s look on the next slide to see an aging of accounts receivable for Skechers (all amounts in thousands).

22. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Next, based on past experience, the business estimates the percentage of uncollectible accounts in each time category. (in thousands) Aging Schedule

23. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Now we will multiply these percentages by the appropriate column totals. (in thousands) Aging Schedule

24. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The column totals are then added to arrive at the total estimate of uncollectible accounts of $7,196. (in thousands) Aging Schedule

25. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Aging of Accounts Receivable Record the year-end adjusting entry assuming that the Allowance for Doubtful Accounts currently has a $4,314,000 credit balance. (in thousands)

26. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin After posting, the Allowance account would look like this... Aging of Accounts Receivable

27. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Notice that the balance after adjustment is equal to the estimate of $7,196,000 based on the aging analysis performed earlier. Aging of Accounts Receivable

28. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Collections of accounts previously written off require that the original write-off entry be reversed before the cash collection is recorded. Let’s record the entry that Skechers would make if $50,000 is collected that had previously been written off. Collections of accounts previously written off require that the original write-off entry be reversed before the cash collection is recorded. Let’s record the entry that Skechers would make if $50,000 is collected that had previously been written off. Other Issues – Account Recoveries

29. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 3 Compute and report interest on notes receivable.

30. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Notes Receivable and Interest Revenue Accounting for notes receivable is similar to accounting for accounts receivable except for interest. Accounts receivable do not charge interest until they become overdue, but notes receivable start charging interest the day they are created.

31. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Calculating Interest Even for maturities less than 1 year, the rate is annualized. Number of months out of twelve that interest period covers.

32. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Reporting Interest on Notes Receivable 11/01/07 12/31/0710/31/08 Record note receivable Accrue interest Record interest and principal received On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008. 2007 Interest 2008 Interest

33. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Recording Notes Receivable On November 1, to record the note: On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.

34. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin $ 100,000 × 12% × 2 / 12 = $ 2,000 Interest revenue is $1,000 per month. Accruing Interest Earned On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.

35. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin On December 31, to accrue $ 2,000 interest receivable: Accruing Interest Earned On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.

36. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin On October 31, to record $112,000 cash received: On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008. Recording Interest Received and Principal at Maturity

37. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Accounting for Uncollectible Notes When the collection of a note receivable is in doubt, a company should record an allowance for doubtful accounts against notes receivable just as is done with accounts receivable.

38. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 4 Compute and interpret the receivables turnover ratio.

39. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Skechers reported 2005 net credit sales of $1,006,000,000. December 31, 2005, receivables were $134,600,000 and December 31, 2004, receivables were $120,400,000. Net Credit Sales Revenue Average Net Trade Receivables Receivables Turnover Ratio = Receivables Turnover Analysis

40. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin = 7.9 times $1,006,000,000 ($134,600,000 + $120,400,000) ÷ 2 = Net Credit Sales Revenue Average Net Trade Receivables Receivables Turnover Ratio = This ratio measures how many times average receivables are recorded and collected for the year. Receivables Turnover Analysis

41. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin This ratio tells us the average number of days it takes a company to collect its receivables. 365 Days Receivables Turnover Ratio Days to Collect = 365 Days 7.9 Days to Collect = = 46.2 Days Receivables Turnover Analysis

42. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin When a company desires to quickly convert receivables into cash, the receivables can be sold to a financing company or bank (called factoring). Factoring Receivables

43. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Credit Card Sales Companies accept credit cards to: 1.To increase sales. 2.To avoid providing credit directly to customers. 3.To avoid losses due to bad checks. 4.To receive payment quicker. Companies accept credit cards to: 1.To increase sales. 2.To avoid providing credit directly to customers. 3.To avoid losses due to bad checks. 4.To receive payment quicker. When credit card sales are made, a fee is paid to the credit card company for the service it provides.

44. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 8 Supplement Percentage of Credit Sales Method

45. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Percentage of Credit Sales Bad debt percentage is based on actual uncollectible accounts from prior years’ credit sales. Focus is on determining the amount to record on the income statement as Bad Debt Expense.

46. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Percentage of Credit Sales

47. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin In the current year Skechers had credit sales of $1,152,800,000. Past experience indicates that bad debts are one-fourth of one percent (.25%) of sales. What is the estimate of bad debt expense for the year? $1,152,800,000 ×.0025 = $2,882,000 Let’s prepare the adjusting entry. Percentage of Credit Sales

48. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Percentage of Credit Sales

49. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin No journal entries are made until a bad debt is discovered. The following journal entry is made to record $1,000 of bad debt expense when a customer account is determined to be uncollectible. Direct Write-Off Method Acceptable for tax purposes, but unacceptable under generally accepted accounting principles.

50. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin End of Chapter 8