ACCOUNTING FOR RECEIVABLES Monday, Dec 1 will be Unit 3 Test (covering chapter 7 and 8) CHAPTER 8

Two methods of accounting for uncollectible accounts are: 1. Allowance method 2. Direct write-off method VALUING ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLEVALUING

Companies use either of two methods in the estimation of uncollectible accounts: 1. Percentage of sales 2. Percentage of receivables Both bases are GAAP; the choice is a management decision. BASES USED FOR THE ALLOWANCE METHOD

Under this approach, you always subtract the beginning balance of the Allowance for DA from the estimated number. For example, The CK’s AR is 240,000 and they estimate that 10% will be uncollectible in the future. Then they should muliply 0.1 * 240,000 = (ending balance must be 24000) But they realized that beginning balance of Allowance for DA is 1000 then the difference is PERCENTAGE OF RECEIVABLES BASIS

ILLUSTRATION 9-4 COMPARISON OF BASES OF ESTIMATING UNCOLLECTIBLES Percentage of Sales Percentage of Receivables Net Realizable Value Allowance Accountsfor ReceivableDoubtful Accounts Emphasis on Income Statement Relationships Emphasis on Balance Sheet Relationships

Companies use various methods for collecting past due accounts including letters, calls, and legal actions. Some companies hire collection agency to collect. When everything was tried and it still seems impossible to collect then the account should be written off. Again, Internal control Purpose : Only manager should authorize write off, otherwise, employees can steal company’s cash. Collection Process

March 1 Allowance for DA 4500 AR – Kids online4500 Writing off AR – Kids online We do not increase bad debt expense, but we increase ADA account and decrease AR. Collection Process

NON-BANK CARD SALES Sales using American Express and other non-bank cards are reported as credit sales, (=debit AR) not cash sales. Conversion into cash does not occur until American Express remits the net amount to the seller.

NON-BANK CARD SALES Kerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 31Accounts Receivable Credit Card Expense ($500 x 5%) Sales To record American Express credit card sales

A promissory note is a written promise to pay a specified amount of money on demand (or at a definite time.) Promissory note is used 1.When individuals (or companies) lend or borrow money. 2.When the amount of the transaction and the credit period are long term or 3.In settlement of accounts receivable NOTES RECEIVABLE

The party making the promise is the maker.(=borrower) The party to whom payment is made is called the payee. (=lender) –The same promissory note is a note payable for maker and it is a note receivable for the payee. NOTES RECEIVABLE

The promissory note gives these details: 1.Name of the maker and payee 2.Amount of the loan 3.Loan period (such as 1 year or 5 years) 4.Interest rate (such as 8%) 5.How interest will be paid = Whether interest is repayable monthly or fully paid at maturity along with the principal 6.Whether any security is pledged as collateral for the loan and what happens if the maker defaults. NOTES RECEIVABLE

AR is informal promise to pay, whereas NR is more formal written promise. The lender has stronger legal claim under NR. NR is a negotiable instrument, which means it can be sold or transferred to another person or company by endorsement. AR results from a credit sale transaction whereas NR results from financing a purchase (such as when buying a car), lending money, or extending AR for a longer period. Difference between NOTES RECEIVABLE and AR

AR is usually due in a short period of time (e.g. 30 days) while a note can extend for longer periods of time. AR does not normally incur interest expense (unless the account is overdue.) A NR usually bears interest for the entire period. Difference between NOTES RECEIVABLE and AR

Both are credit instruments. Both are valued at their net realizable values. Both can be sold to another party. The basic issues in accounting for notes receivable are the same as those for AR as follows: 1.Recognizing NR 2.Disposing NR Similarities of NOTES RECEIVABLE and AR

The basic formula for calculating interest on an interest-bearing note is: The interest rate specified on the note is an annual rate of interest. For example 1000 * 0.06 * 6/12 = 30$ for 6 months ILLUSTRATION 9-8 FORMULA FOR CALCULATING INTEREST Face Value of Note Annual Interest Rate Loan Period in Terms of One Year Interest X X =

RECOGNIZING NOTES RECEIVABLE Wilma Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company to settle an open account. (Brant bought merchandise on account on March 15. Brant did not pay in 30 days, but they will pay in the future. ) 1,000

HONOUR OF NOTES RECEIVABLE A note is honoured when it is paid in full at its maturity date. Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5% interest-bearing note, due in 4 months, on September 30. Wolder collects the maturity value of the note from Higley on September 30.

Adjusting Entry on July 31 If the year end was July 31, and the note receivable from previous example was still outstanding, then they should make the following adjusting entry to honor matching principle. Two months have passed from the issue date, so we must recognize two months of accrued interest * 2/12 * 10,000 = 75 July 31 Interest Receivable75 Interest Revenue 75 Sep 30 Cash10150 Interest Receivable 75 Notes Receivable Interest Revenue75

Like accounts receivable, short-term notes receivable are reported at their net realizable value. (you must estimate how much of it will actually be collected) The notes receivable allowance account is Allowance for Doubtful Notes. (or ADN, which is same as ADA) Use bad debt expense and ADN to write off. VALUING NOTES RECEIVABLE

Classwork / Homework P438 E8.7, E8.8 P443 P8.8

DISHONOUR OF NOTES RECEIVABLE A dishonoured note is a note that is not paid in full at maturity. A dishonoured note receivable is no longer negotiable. Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable or ADA

RECOGNIZING NOTES RECEIVABLE If a note is made to get cash, then the entry is a debit to Notes Receivable and credit to Cash. (For borrower) Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company. Interest will be recorded later when it is paid. 1,000