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2. Chapter 8 Reporting and Interpreting Receivables, Bad Debt Expense, and Interest Revenue PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Fred Phillips, Ph.D., CA

3. Record sales on account dr Accounts Receivable cr Sales Revenue Balance Sheet Cash Accounts Receivable Inventory … Income Statement Sales Revenue Cost of Goods Sold Gross Profit … Bad debt known Accounts Receivable and Bad Debts Jan. 1 8-3

4. Record sales on account dr Accounts Receivable cr Sales Revenue Balance Sheet Cash Accounts Receivable Inventory … Income Statement Sales Revenue Cost of Goods Sold Gross Profit … Bad debt known Balance Sheet Cash Accounts Receivable Less: Allowance for Doubtful Accounts Accounts Receivable, Net Inventory … Income Statement Sales Revenue Cost of Goods Sold Gross Profit Bad Debt Expense … Accounts Receivable and Bad Debts Record estimate of bad debts Jan. 1Jan. 31 dr Bad Debt Expense (+E, -SE) cr Allowance for Doubtful Accounts (+xA, -A) 8-4

5. Record sales on account dr Accounts Receivable cr Sales Revenue Balance Sheet Cash Accounts Receivable Inventory … Bad debt known Balance Sheet Cash Accounts Receivable Less: Allowance for Doubtful Accounts Accounts Receivable, Net Inventory … Accounts Receivable and Bad Debts Record estimate of bad debts Jan. 1Jan. 31 dr Bad Debt Expense (+E, -SE) cr Allowance for Doubtful Accounts (+xA, -A) dr Allowance for Doubtful Accounts (-xA) cr Accounts Receivable(-A) 8-5

6. Allowance Method The allowance method follows a two-step process, described below: 1.Make an end-of-period adjustment to record the estimated bad debts in the period credit sales occur. 2.Remove (“write off”) specific customer balances when they are known to be uncollectible. The allowance method follows a two-step process, described below: 1.Make an end-of-period adjustment to record the estimated bad debts in the period credit sales occur. 2.Remove (“write off”) specific customer balances when they are known to be uncollectible. 8-6

7. 2. Remove (Write-off) Specific Customer Balances 8-7

8. Methods for Estimating Bad Debts There are two acceptable methods of estimating the bad debts in a given period. 1.Percentage of Credit Sales Method. 2.Aging of Accounts Receivable. Simpler to apply. More accurate 8-8

9. Percentage of Credit Sales Method The percentage of credit sales method estimates bad debt expense by multiplying the historical percentage of bad debt losses by the current period’s credit sales. Net credit sales for the period × Historical bad debt loss rate = Bad debt expense of the period. 8-9

10. Aging of Accounts Receivable While the percentage of credit sales method focuses on estimating Bad Debt Expense (income statement approach) for the period, the aging of accounts receivable method focuses on estimating the ending balance in the Allowance for Doubtful Accounts (balance sheet approach). The aging method gets its name because it is based on the “age” of each amount in Accounts Receivable at the end of the period. The older and more overdue an account receivable becomes, the less likely it is to be collectible. 8-10

11. Other Issues Let’s assume that Skechers collects the $800 from Fast Footwear that was previously written off. This recovery would be recorded with the following journal entries: (1) Reverse the write-off. (2) Record the collection. 8-11

12. Calculating Interest Interest (I) = Principal (P) × Interest Rate (R) × Time (T) The time period for interest calculation The amount of the note receivable See if you can calculate the interest below using your calculator. The annual interest rate charged on the note 8-12

13. Recording Notes Receivable and Interest Revenue The four key events that occur with any note receivable are: Date of Note ReceivableNovember 1, 2009 Annual Interest Rate6% Amount of the Note$100,000 Maturity Date of NoteOctober 31, 2010 Year End of CompanyDecember 31, 2009 Date of Note ReceivableNovember 1, 2009 Annual Interest Rate6% Amount of the Note$100,000 Maturity Date of NoteOctober 31, 2010 Year End of CompanyDecember 31, 2009 8-13

14. Receivables Turnover Analysis The receivables turnover ratio indicates how many times, on average, this process of selling and collecting is repeated during the period. The higher the ratio, the faster the collection of receivables. Rather than evaluate the number of times accounts receivable turn over, some people find it easier to think in terms of the number of days to collect receivablese (called days to collect). 8-14

15. Direct Write-Off Method On October 13, 2009, we sold merchandise on account to Fast Footwear for $1,000. On February 1, 2010, Fast Footwear declared bankruptcy and had made no payments toward the $1,000 balance in its account receivable. 2 Record February 1, 2009 8-15

16. End of Chapter 8