Reporting and Analyzing Receivables Chapter 8 Reporting and Analyzing Receivables

Accounting for Receivables A receivable is a company’s claims for money, goods, or services. An account receivable is classified as a current asset representing money due for services performed or merchandise sold on credit. When an account becomes uncollectible, a bad debt expense is incurred.

Example: Accounts Receivable Assume merchandise is sold on account for $1,000. The terms of the agreement were 2/10, n/30. The entries are as follows:

Example: Accounts Receivable Assume merchandise is sold on account for $1,000. The terms of the agreement were 2/10, n/30. The entries are as follows: Credit Sale: Accounts Receivable 1,000 Sales Revenue 1,000

Example: Accounts Receivable Assume merchandise is sold on account for $1,000. The terms of the agreement were 2/10, n/30. The entries are as follows: Credit Sale: Accounts Receivable..... 1,000 Sales Revenue......... 1,000 Collection--2/10,n/30: Cash.............................. 980 Sales Discounts............. 20 Accounts Receivable 1,000

Uncollectible Accounts Some receivables will never be collected and must be written off as uncollectible.

Uncollectible Accounts Occurs when customers do not pay for items or services purchased on credit. Bad Debts are uncollectible accounts receivables. The uncollectible expense is placed on the income statement as a selling expense.

Two Methods of Accounting for Uncollectible Accounts Direct Method Or: Allowance Method

EXAMPLE: If We Have $100,000 in A/R Invoice ABC Inc. $ They would be represented by a stack of invoices Direct Method Under the All invoices are presumed to be good . . . (Valued at $100,000) until we discover someone can’t pay the amount owed.

Direct Method Invoice ABC Inc. $ When an invoice is discovered to be uncollectible — it must be removed from A/R. That is it must be expensed or written off.

Direct Method Journal Entry to record Bad Debt: Dr. Cr. Invoice ABC Inc. $ Journal Entry to record Bad Debt: Dr. Cr. Bad Debt Expense 500 Accounts Receivable 500

Direct Method Problem: Invoice ABC Inc. $ Problem: Accounts Receivable is reported at the full $100,000 until bad debts are specifically identified. But, we know some customers in the stack will not pay. So, what is the real value of A/R?

Direct Method Invoice ABC Inc. $ Like all assets, the value of A/R is only what you expect to collect. Accounts Receivable is overstated. Bad debt expense is understated! It is not recorded in the same period the sale was made.

The Matching Principle Requires expenses be recorded in the same period the corresponding revenue is recognized. Direct Method is in conflict with the Matching Principle Not accepted under GAAP

Allowance Method If We Have $100,000 in A/R Under the Allowance Method Invoice ABC Inc. $ If We Have $100,000 in A/R We presume some invoices will not be good . . . We just don’t know which ones.

Allowance Method How do we write off an unknown amount of Accounts Receivable? ESTIMATE the amount, but don’t remove any invoices from A/R

An estimate can be based on: Allowance Method An estimate can be based on: Size of the receivables Age of the receivables Past loss experience All of the above

An estimate can be based on: Allowance Method An estimate can be based on: Size of the receivables Age of the receivables Past loss experience All of the above

Allowance Method Assume you made an estimate that $2000 will not be collectable. What journal entry would you make? Dr. Cr. Hint: Accounts Receivable is NOT reduced because which invoices will become uncollectable is unknown!

Allowance Method Dr. Cr. Bad Debt Expense 2000 Allowance for Doubtful Accounts 2000 To record estimated bad debts

Balance Sheet Presentation Assets: Cash 20,000 Accounts Receivable 100,000 Supplies 2,500 PP&E 3,000,000 Total Assets 3,120,500 The Allowance for Doubtful Accounts is a contra asset that follows A/R

Balance Sheet Presentation Assets: Cash 20,000 Accounts Receivable 100,000 Less Allowance for DA 2,000 Net Accounts Receivable 98,000 Supplies 2,500 PP&E 3,000,000 Total Assets 3,120,500 Note: Accounts Receivable is NOT reduced but the net receivable is!

Allowance Method Journal Entry needed when an account is identified as uncollectible: Dr. Cr. Allowance for Doubtful Accounts 500 Accounts Receivable 500 To write off Smith Co. (in bankruptcy)

Direct vs. Allowance Methods The difference is TIMING Direct Method Dr. Cr. May 5 Bad Debt Expense 500 Accounts Receivable 500 Allowance Method Dr. Cr. Dec 31 Bad Debt Expense 2000 Allowance for DA 2000 May 5 Allowance for DA 500 Accounts Receivable 500

Allowance Method (1) The Allowance for Doubtful Accounts is a contra-asset account which is subtracted from accounts receivable on the balance sheet. (2) The actual write-off entry does not reduce net receivables, as shown below: Acct Receivable $100,000 Acct Receivable $99,500 Less Allowance for Less Allowance for Doubtful Accounts 2,000 Doubtful Accounts 1,500 Net Receivables $ 98,000 Net Receivables $98,000

Allowance Method (1) The Allowance for Doubtful Accounts is a contra-asset account which is subtracted from accounts receivable on the balance sheet. (2) The actual write-off entry does not reduce net receivables. (3) The estimation error inherent in this approach is more acceptable than the violation of matching with the direct write-off method.

Reversing Written-Off Receivables Reverse Write Off: Accounts Receivable 500 Allowance for Doubtful Accounts 500 To reinstate a written-off receivable.

Reversing Written-Off Receivables Reverse Write Off: Accounts Receivable 500 Allowance for Doubtful Accounts 500 To reinstate a written-off receivable. Eliminate Receivable: Cash 500 Accounts Receivable 500 Payment for written-off receivable.

Estimating the Allowance for Uncollectible Accounts Percentage of Total Receivables-- Determines the desired balance for Allowance for Doubtful Accounts. The difference between the actual and the desired balance is the expense entry. Aging Method--The process of categorizing each account receivable by the number of days it has been outstanding.

Example: Bad Debt Expense The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for doubtful accounts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected.

Allowance for Doubtful Accounts Example: Bad Debt Expense The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for doubtful accounts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected. Bad Debt Expense 350 Balance Expense 2,701 2,701 Expense End. Balance 2,701 3,051 End. Bal. Allowance for Doubtful Accounts

Allowance for Doubtful Accounts Example: Bad Debt Expense The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for doubtful accounts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected. Bad Debt Expense 350 Balance Expense 2,701 2,701 Expense End. Bal. 2,701 3,051 End. Bal. Allowance for Doubtful Accounts Bad Debt Expense 2,701 Allowance for Doubtful Accounts 2,701 To adjust the Allowance account to desired balance.

Example 2: Bad Debt Expense The XYZ Company had credit sales during the year of $200,000. Using the Aging Method, determine the journal entry needed. The beginning balance for the Allowance for Doubtful accounts is $150. Percentage Estimated to be Age Balance Uncollectible Amount Current.............. $10,000 1.5 $ 150 1-30 days.......... 4,000 4.0 160 31-90 days........ 2,100 20.0 420 Over 90 days..... 1,000 40.0 400 $17,000 $1,130

Uncollectible Account Allowance for Doubtful Accounts Example 2: Bad Debt Expense The XYZ Company had credit sales during the year of $200,000. Using the Aging Method, determine the journal entry needed. The beginning balance for the Allowance for Doubtful accounts is $150. Uncollectible Account Expense Allowance for Doubtful Accounts 150 Balance Expense 980 980 Expense End. Bal. 1,130 End. Bal. 980

Uncollectible Account Allowance for Doubtful Accounts Example 2: Bad Debt Expense The XYZ Company had credit sales during the year of $200,000. Using the Aging Method, determine the journal entry needed. The beginning balance for the Allowance for Doubtful accounts is $150. Uncollectible Account Expense Allowance for Doubtful Accounts 150 Balance Expense 980 980 Expense End. Bal. 980 1,130 End. Bal. Uncollectible Account Expense 980 Allowance for Doubtful Accounts 980 To adjust the Allowance account to desired balance.

Accounting for Uncollectible Receivables (Percentage of Credit Sales) The ABC company had credit sales during the year of $100,000. They estimate that 3% of all credit sales will be uncollectible. Assuming the allowance for doubtful accounts has a debit balance of $ 1,000 what entry is necessary?

Accounting for Uncollectible Receivables (Percentage of Credit Sales) The ABC company had credit sales during the year of $100,000. They estimate that 3% of all credit sales will be uncollectible. Assuming the allowance for doubtful accounts has a debit balance of $ 1,000 what entry is necessary? Uncollectible Accounts Expense 4,000 Allowance for Uncollectible Accounts 4,000 To record estimated uncollectible accounts for the year.

Assessing Management of Receivables Accounts Receivable Turnover--A measure used to determine a company’s average collection period for receivables. Computed by dividing net sales (credit sales) by average accounts receivables.

Assessing Management of Receivables Accounts Receivable Turnover Number of Days in Receivables--A measure of the average number of days it takes to collect a credit sale. It is computed by dividing 365 days by the accounts receivable turnover.

Example The Wheeler Company had Net Credit Sales of $150,000 during 2009. The accounts receivables increased $5,000 to $40,000 during the same time. Calculate the Accounts Receivable Turnover and Number of Days in Receivables.

Example The Wheeler Company had Net Credit Sales of $150,000 during 2009. The accounts receivables increased $5,000 to $40,000 during the same time. Calculate the Accounts Receivable Turnover and Number of Days in Receivables. Accounts Receivable Turnover: Net Sales $150,000 = 4.0 Average Accounts Receivable $ 37,500

Example The Wheeler Company had Net Credit Sales of $150,000 during 2009. The accounts receivables increased $5,000 to $40,000 during the same time. Calculate the Accounts Receivable Turnover and Number of Days in Receivables. Number of Days in Receivables: Number of Days 365 = 91.25 Accounts Receivable Turnover 4.0

Notes Receivable A written promise that allows someone to pay a certain amount of money on or before a specific future date. Notes are classified as current or long-term assets, depending on the due date.

Notes Receivable -- Components Maker--The individual who signs the note and assumes responsibility. Payee--The person to whom payment is made. Principal--The face amount of the note. Maturity Date--The date the note becomes due. Interest Rate--Annualized percentage of the principal the maker is charged to borrow money. Interest--The cost of borrowing money.

Computing Interest Principal (amount)

Computing Interest Principal (amount) Interest Rate (%) X

X X Computing Interest Principal (amount) Interest Rate (%) Time (years) X X

X X Equals Computing Interest Principal (amount) Interest Rate (%) Time (years) X X Equals Interest Owed

Example: Interest The Ohio Company signed a 90-day, $5,000 note payable to the Florida Company in settlement of existing accounts payable. The interest rate of the agreement is 14 percent. Calculate the interest cost.

Example: Interest $5,000 x 0.14 x 90/365 = $172.60 The Ohio Company signed a 90-day, $5,000 note payable to the Florida Company in settlement of existing accounts payable. The interest rate of the agreement is 14 percent. Calculate the interest cost. Principal x Interest Rate x Time = Interest $5,000 x 0.14 x 90/365 = $172.60 What journal entries are required for the Ohio Company? For the Virginia Company?

Journalizing Notes Receivable The Ohio Company--Maker Accept Note: Accounts Payable............ 5,000.00 Note Payable............. 5,000.00 Pay Note Plus Interest: Note Payable................... 5,000.00 Interest Expense.............. 172.60 Cash.......................... 5,172.60

Journalizing Notes Receivable The Virginia Company--Payee Accept Note: Note Receivable............... 5,000.00 Accounts Receivable.. 5,000.00 Collect Note Plus Interest: Cash................................. 5,172.60 Note Receivable......... 5,000.00 Interest Revenue........ 172.60

Selling or Factoring Receivables Receivables are sold to factoring companies for cash. The factoring companies charge a percentage of the receivable as a service cost. Factoring allows companies to receive cash now, instead of waiting to collect on the receivable.