Accounts Receivable (AR) Nature of, discounts (gross, net), allowance (income statement, balance sheet approach) versus direct write-off approach concerning bad debts, financing through pledging, assigning or factoring AR, and AR turnover

Nature of Accounts Receivable Trade obligations of customers for goods and services Assume collection reasonably assured Cash versus additional revenue (Cost versus benefit) Net realizable value = AR – allowance for doubtful accounts (conservatism) Quality of AR determined from collectability of AR within credit terms (AR turnover) To improve cash flow, may offer a time discount, such as 1% if paid in 12 days, and must be paid by day 30 -- 1/12, net 30

AR Time discounts – net and gross method Adjusts for discount right away and shows the net amount Displays “Discounts Lost” account if not taken (revenue) Conservative amount for Sales revenue and AR Adjusts for discount when customer pays in discount period Displays “Sales Discounts” account for discounts actually taken (contra revenue) If material should estimate future sales discounts to be taken and journalize as an adjusting entry

Aging of Accounts Receivable and Accounts Receivable turnover –how efficiently are we collecting on account? What is probability of collecting on AR? Higher if done sooner, more current! AR subsidiary checked for dates of customer purchases on account for aging Group customers into categories – not past due, 1-30 days past due, etc. Estimate bad debts for each category, still a guess though may be more accurate than a flat %! AR turnover – net credit sales/average AR (X times or # of days)

Direct write-off method versus the allowance method – matching and materiality Quicker and easier to use No estimating Expense actual bad debts when an account is deemed uncollectible Violates matching Ok to use if very few credit customers or not materially different than allowance approach More complicated Bad debts estimated and expensed in the same period as the sales revenue Supports matching

Allowance Approach to Bad Debts- Match bad debt expense to sales revenue, requiring estimation of bad debts and the use of the “allowance for bad debts” (AFBD) Income statement approach Balance sheet approach % of sales revenue for bad debt estimate (ex. .5% of $2 million net sales = $2000 with no adjustment for AFBD balance, becomes amount in journal entry) Focus on “bad debt expense” No beginning balance in bad debt expense Easier of methods The calculation becomes the amount used in the journal entry AR and allowance could get out of sync requiring a one time correction % of AR, such as an aging of AR with estimation %’s for bad debt(ex. 2% of $100,000 ending AR to equal net realizable value (NRV)) Focus on “net realizable value” of AR Usually a beginning balance in the allowance for bad debts –overestimated last year, journalize less in bad debts this year A more complicated method Forces AR and allowance to be in sync

Financing Accounts receivable- secured borrowing Assignment Pledging AR is collateral for loan Assigned usually with recourse Often customer pays assignor “AR assigned” –separated from other assets, proceeds for payment of loan “Assignment service charge expense” & “interest expense” Assignor responsible for sales returns & allowances, bad debts AR is collateral for loan Footnote only –some AR collections may not be available to creditors AR could be transferred to 3rd party No special accounting for this – no additional journal entries

Financing with Accounts Receivable --factoring Sale without recourse (WOR) Sale with recourse (WR) Transferor (seller) loses control of AR Transferee (factor) has rights (sell, etc.) Often customer pays transferee (factor) Advance less than 100% to cover returns “factoring expense” higher than WR Transferor (seller) responsible for sales returns & allowances Transferee (factor) responsible for bad debts Transferor (seller) loses control of AR Transferee (factor) has rights (sell, etc.) Often customer pays transferee (factor) Advance less than 100% to cover returns “factoring expense” lower than WOR Transferor (seller) responsible for sales returns & allowances Transferor (seller) responsible for bad debts-seller guaranteeing factor will be paid Financial components approach, ”recourse liability” shows estimated fair value on transferor’s (seller’s) books, estimated bad debts