Accounting for Receivables Acct 2210 Chapter 7 (Omit pg ) McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Explain how the allowance method of accounting for uncollectible accounts affects financial statements. LO 1 7-1

Accounts Receivable and Notes Receivable When a company allows customers to “buy now and pay later,” the company’s right to collect cash in the future is called accounts receivable. Individually, these receivables are typically small and are payable within 30 days. When a longer credit term is needed, or when the receivable is large, the company usually requires the customer to issue a note that specifies interest and other credit terms. The company then records a note receivable. 7-2

Credit Terms and Bad Debts Some customers may be unwilling or unable to pay their accounts receivable. As a result, we do not want to overstate assets, and must show accounts receivable at its “net realizable value” (NRV) on the balance sheet. The NRV is the gross amount of the receivables less some estimated “allowance for doubtful accounts”. Multiplying the service revenue by the percentage estimate of uncollectible accounts is commonly called the “percent of revenue method” of estimating uncollectible accounts expense. 7-3

Revenue Recognition Event 1 Revenue Recognition During 2013, Allen’s Tutoring Services, a service company, renders services on account for customers in the amount of $14,

Collection for Receivables Event 2 Collection of Receivables During the year, ATS collects cash of $12,500 on its accounts receivable. 7-5

Recognizing Uncollectible Accounts Expense Event 3 Recognizing Uncollectible Accounts Expense Based upon past experience, ATS estimates that $75 of its current accounts receivable balance will eventually prove to be uncollectible. 7-6

General Ledger Accounts 7-7

Financial Statements Panel C Financial Statements for

Subsequent Period Event 1 Write-Off of an Uncollectible Account Receivable During 2014, ATS determines that an account receivable of $70 will not be collected. The company elects to write-off the account. 7-9

Revenue Recognition Event 2 Revenue Recognition During 2014, ATS renders services on account in the amount of $10,

Collections on Account Receivable Event 3 Collection on Accounts Receivable During 2014, ATS collects $8,430 on its accounts receivable. 7-11

Reinstate Account Receivable Event 4 Reinstatement of Account Written-Off Of the accounts receivable previously written off, it turns out that the company will collect $

Recovery on Account Event 5 Collection of Recovered Amount Of the accounts receivable previously written off, it turns out that the company will collect $

Using the “percent of revenue” method to estimate uncollectible accounts expense. LO 2: Our focus will be the use of this method of determining uncollectible accts. 7-14

Year-End Adjusting Entries Event 6 Adjustment for Bad Debts Expense At the end of 2014, ATS estimates that its bad debts will amount to 1.35% of its service revenue. 7-15

General Ledger T-Accounts 7-16

Financial Statements Panel C Financial Statements for

(OMIT pg ) Using the “percent of receivables” method to estimate uncollectible accounts expense. LO 3 Students are NOT responsible for this method. It is shown simply to indicate that two approaches could be used. Our focus will be on the “Percent of Revenue” (LO 2) method only. 7-18

Aging Schedule 7-19

Balance Required under the Percent of Receivables Method 7-20

Computing Uncollectible Accounts Expense 7-21

Show how the Direct write-off method of accounting for uncollectible accounts affects financial statements. LO 4 (Class Discussion Only) 7-22

Direct Write-Off Method Recall that in 2013, ATC recognized $14,000 of revenue on account. No entry will be made at year-end to estimate uncollectible accounts expense if ATC believes that amount will be immaterial. 7-23

Direct Write-Off Method – Writing Off an Account During 2014, the company determines that a customer who owes $70 is unable to pay. 7-24

Direct Write-Off Method – Recovery of a Written-Off Account Also in 2014, ATC collects $10 from an account that had been previously written off. ATC first reinstates the account by reversing the write-off. 7-25

Direct Write-Off Method – Recovery of a Written-Off Account Once the account is reinstated, the event is recorded the same as the collection of any other receivable. 7-26

Explain how accounting for notes receivable and accrued interest affects financial statements. LO

Accounting for a Promissory Note 7-28

Notes Receivable Event 1 Loan of Money On November 1, 2013, ATS loans $15,000 cash to Stanford Cummings. Cummings issues ATS a note promising to repay the loan, with interest, in one year. 7-29

Interest Revenue Event 2 Recognition of Interest Revenue At the end of 2013, ATS must accrue the interest earned on its note receivable (i.e. Nov – Dec, 2013). $15,000 × 6% × 2/12 = $150 interest revenue 7-30

Collection of a Note Receivable Event 3 Collection of Principal and Interest On October 31, 2014, ATS collects the principal and interest due on the note receivable. ATS first recognizes interest revenue for the 10 months of 2014 (i.e. Jan – October, 2014). $15,000 × 6% × 10/12 = $750 interest revenue 7-31

Collection of a Note Receivable Event 3 Collection of Principal and Interest Now that the entire $900 of interest receivable has been accrued, ATS records the collection of $15,900 in principal and interest on the note. 7-32

Explain how accounting for credit card sales affects financial statements. LO

Credit Card Sales Rather than maintaining a credit-granting department, many companies find it cost beneficial to accept credit cards. The credit card company deducts a fee, usually between 2% and 8%, from the gross amount of the sales, and pays the merchant the net balance (gross sales less credit card fee). 7-34

Credit Card Sales Event 1 Recording a Credit Card Sale ATS accepts a credit card in payment for services of $1,000. The credit card company charges a fee of 5% of the transaction. 7-35

Credit Card Sales Event 2 Collection of a Credit Card Receivable ATS collects the full amount due from the credit card company. 7-36

Explain the effects of the cost of financing credit sales. LO

Accounts Receivable Turnover Accounts Receivable Turnover Ratio Sales Accounts Receivable = The longer it takes to collect accounts receivable, the greater the opportunity cost of lost income. 7-38

Days to Collect Receivable This ratio often helps simplify the issues surrounding the collections of accounts receivable. Average Number of Days to Collect Accounts Receivable = 365 Accounts Receivable Turnover Ratio 7-39

Operating Cycle The operating cycle is the average time it takes a business to convert inventory to accounts receivable plus the time it takes to convert accounts receivable back into cash. 7-40

End of Chapter Seven 7-41