Tools for Business Decision-Making Fourth Canadian Edition Financial Accounting: Prepared by: Peggy Coady Memorial University of Newfoundland & Catherine Seguin University of Toronto

Reporting and Analyzing Receivables Chapter 8

3 Types of Receivables Amounts due from individuals and companies that are expected to be collected in cash Frequently classified as –Accounts receivable –Notes receivable –Other receivables

Chapter 8 4 Accounts Receivables Revenue recognition principle requires that the receivable be recorded when service is provided or at point of sale of merchandise on account Accounts Receivable 100 Sales100

Chapter 8 5 Accounts Receivable Subsidiary Ledger Subsidiary ledger is a group of accounts that share a common characteristic The subsidiary ledger for accounts receivable provides the details that support the accounts receivable control account in the general ledger

Chapter 8 6 Interest Revenue Some retailers add interest to accounts receivable accounts that are not paid within a specified time period Accounts Receivable 25 Interest Revenue 25

Chapter 8 7 Discussion Question What kind of receivables would a hospital report on its balance sheet?

Chapter 8 8 Recording Estimated Uncollectible Accounts The matching principle dictates that the bad debt expense must be recorded in the period when the related revenue is earned There are many acceptable methods to estimate uncollectible accounts

Recording Estimated Uncollectible Accounts Percentage of receivables basis –Apply percentage to total receivables –Apply percentage to receivables classified according to the length of time they have been outstanding (known as aging the accounts receivable) Chapter 8 9

Recording Estimated Uncollectible Accounts Net realizable value –Net amount expected to be collected in cash –Excludes amounts the company estimates it will not collect –Keeps receivables from being overstated on the balance sheet Chapter 8 10

Recording Estimated Uncollectible Accounts Net realizable value –To reduce accounts receivable to its net realizable value, it is not feasible to credit the Accounts Receivable account directly: 1.We don’t know which individual customers will not pay their receivable balance in the future 2.The amount that will not be collected can only be estimated now Chapter 8 11

Recording Estimated Uncollectible Accounts Net realizable value –As a result, a contra asset account, Allowance for Doubtful Accounts, is credited for the estimated uncollectible amount. Chapter 8 12

Chapter 8 13 Recording Estimated Uncollectibles Abrams Furniture has credit sales of $1,200,000, of which $200,000 remains uncollected. The credit manager estimates $11,000 will prove uncollectible. The adjusting entry must take into consideration any opening balance in the allowance account

Chapter 8 14 Recording Estimated Uncollectibles The percentage of receivables method gives you the BALANCE in the Allowance account, not the amount of the adjustment. Bad Debts Expense10,000 Allowance for Doubtful Accounts10,000 Adj. entry 10,000 Dec. 31 Bal. 11,000 Allowance for Doubtful Accounts. Jan. 1 Bal. 1,000

Chapter 8 15 ABRAMS FURNITURE Balance Sheet (partial) Current assets Cash $ 14,800 Accounts receivable $200,000 Less: Allowance for doubtful accounts 11,000189,000 Net realizable value

Chapter 8 16 Recording the Write-Off of an Uncollectible Account The vice president of finance authorizes a write-off of $2,500 owed by T. Ebbet: Accounts Receivable Allowance for Doubtful Accounts Jan.1 Bal 227,500 Mar. 1 2,500 Mar. 1 Bal 225,000 Jan.1 Bal 11,000 Mar. 1 2,500 Mar. 1 Allowance for Doubtful Accounts2,500 Accounts Receivable—Ebbet2,500 Mar. 1 Bal 8,500

Chapter 8 17 Recording the Recovery of an Uncollectible Account Accounts Receivable—Ebbet2,500 Allowance for Doubtful Accounts2,500 Cash2,500 Accounts Receivable2,500 Record in two separate entries

Chapter 8 18 Discussion Question Why is it important to match bad debt expenses to its related revenue?

Notes Receivable Stronger legal claim to assets than accounts receivable; written promise (promissory note) to repay Credit instrument normally requires –Payment of interest –Extends for time periods of days or longer Chapter 8 19

Chapter 8 20 Notes Receivable Often accepted from customers who need to extend payment of an account receivable Often required from high risk customers To record note receivable: Dr. Note Receivable (face value) Cr. Cash, A/R, or Sales

Chapter 8 21 Formula for Calculating Interest 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. Face Value of Note Annual Interest Rate Time in Terms of One Year Interest X X =

Notes Receivable Honoured –Paid in full at maturity date –Collection recorded Chapter 8 22

Notes Receivable Dishonoured –Not paid at maturity date; note no longer negotiable –Balance transferred to Accounts Receivable if eventual collection expected –Balance transferred to Allowance account if eventual collection not expected Chapter 8 23

Chapter 8 24 Discussion Question What are the main differences and similarities between accounts receivable and notes receivable?

Chapter 8 25 Managing Receivables Determine to whom to extend credit Establish a payment period Monitor collections Evaluate the liquidity of receivables Accelerate cash receipts from receivables when necessary

Evaluating the Liquidity of Receivables Liquidity is measured by how quickly certain assets can be converted into cash –Receivables turnover –Average collection period Chapter 8 26

Receivables Turnover Is a measure of the liquidity of receivables Chapter 8 27 Receivables Turnover = Net Credit Sales Average Gross Receivables

Average Collection Period Is the average amount of time that a receivable is outstanding Chapter 8 28 Average Collection Period = 365 days Receivables Turnover

Chapter 8 29 Discussion Question What do the receivables turnover ratio and average collection period reveal?

Accelerate Cash Receipts from Receivables Loans secured by receivables Sale of receivables –Securitization –Credit card sales –Debit card sales Chapter 8 30

Chapter 8 31 Credit and Debit Card Sales These sales have a cost to the business, which must be recorded at the time of sale For example, the business has to pay the bank a certain percentage of each sale, in addition to incurring other costs of using credit/debit cards

Chapter 8 32 Credit and Debit Card Sales A sale of $100 would be recorded as follows, assuming a 2% fee was incurred: Dr. A/R (for nonbank credit card) OR Cash (for bank credit card or debit card)98 Dr. Credit/Debit Card Expense 2 Cr. Sales Revenue 100

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