Receivables Setting credit policies Accounting for bad debt Computing interest

Setting credit policies Why sell on credit ??? –Increase sales ??? –To remain competitive

Setting credit policies Should I sell on credit to you? –Credit department Approve credit sales –Small businesses Generally prefer credit cards –In effect, company’s credit department –Credit scoring for individuals If denied credit, can get free copy of credit report –Want stability –Don’t apply for a lot of cards at the same time Credit reports can impact job, rental, life insurance

Bad Debts and Valuing A/R Bad debts: an expense of selling on credit –It should be matched with sales period that generate bad debts (matching principle) –If no bad debts…

Methods of recording bad debt expense Direct charge-off: record expense at the time you find you won’t be paid –Entry Bad Debts Expense A/R –Acceptable for income tax purposes –Not acceptable for GAAP as violates matching principle

Allowance Method Bad debt expense is matched against sales in period the sales were recorded –Losses must be estimated since companies don’t know in the period of sale which account will go bad Should take into account prior experience and current economic conditions Must be realistic Subject to manipulation ???

ADA On balance sheet –Caterpillar – A/R 5,611 – - ADA - 376

Allowance Methods Percent of sales method Net sales x % bad debt For example, $1 million x 5% Then make this entry –Bad debts expense $50,000 – ADA $50,000 Focus: income statement, not balance sheet Not concerned about ADA balance

Allowance Methods A/R aging method A/R is aged –Further past due, likelihood of bad debts grows rapidly For example, 4% of < 30 days; 40% over 90 days Multiply A/R x % bad debt for each time period Calculate total balance needed in ADA Assume need $50,000 and $20,000 already in ADA Then make this entry –Bad debts expense $30,000 – ADA $30,000 Focus: balance sheet, not income statement Not concerned about Bad Debts expense

Entry for write-off of A/R Already recorded expense when estimated bad debts expense under one of allowance methods –Entry: ADA A/R –Reduces ADA and A/R –Net A/R remains the same –If underestimate bad debts, ADA will have a debit balance

Credit Cards VISA and MasterCard –Credit card slips are similar to depositing checks into company bank account –Discount may range from 2-4% –Entry Cash98 Credit card expense 2 Sales100

Credit Cards Factoring –Sale of receivables –With recourse? –Cost of funds?

Credit Cards Store credit card –No discount fees –Entry A/R100 Sales100

Gift Cards Store gift cards –Stores love these –Entry Cash100 ?????100 –On expiration date

Notes Receivable Promissory note versus A/R A/R –No interest –Unsecured creditor N/R –Interest –Secured creditor

Calculating Interest Principal x Rate x Time Principal = amount loaned Make sure time and rate are expressed in same units Interest on $1,000 for 30 days at 10% –360 day versus 365 day method