1. ACCOUNTING PRINCIPLES SIXTH CANADIAN EDITION Prepared by: Debbie Musil Kwantlen Polytechnic University Chapter 8 Accounting for Receivables

2. Accounts receivable –Recognition and valuation Notes receivable –Recognition and disposition Statement presentation and management of receivables –Presentation –Analysis –Accelerating cash receipts from receivables Copyright John Wiley & Sons Canada, Ltd. 2

3. STUDY OBJECTIVES: CHAPTER 8: Accounting for Receivables 1.Record accounts receivable transactions. 2.Calculate the net realizable value of accounts receivable and account for bad debts. 3.Account for notes receivable. 4.Demonstrate the presentation, analysis and management of receivables. Copyright John Wiley & Sons Canada, Ltd. 3

4. Types of Receivables Amounts due from individuals and other companies Accounts receivable: –Amounts owed by customers on account –Expected to be collected within 30 days Notes receivable: –Supported by formal instruments of credit (a written note) –For periods of 30 days or longer –Interest bearing Copyright John Wiley & Sons Canada, Ltd. 4

5. Recognizing Accounts Receivable A receivable is recorded when: –Services are provided –Merchandise is sold on account Copyright John Wiley & Sons Canada, Ltd. 5

6. Subsidiary Accounts Receivable Ledger Used to track individual customer accounts Each entry is effectively posted twice: –To the subsidiary ledger –To the general ledger in summary form Copyright John Wiley & Sons Canada, Ltd. 6

7. Interest Revenue If a customer does not pay in full within a specified period, financing charges (interest) is added to the balance due –Recognized as interest revenue Copyright John Wiley & Sons Canada, Ltd. 7

8. Nonbank Credit Card Sales Nonbank credit card sales are treated as sales on account –Unlike bank credit card sales - treated as cash sales –Receipt of cash from nonbank credit cards is recorded as follows Copyright John Wiley & Sons Canada, Ltd. 8

9. STUDY OBJECTIVES: CHAPTER 8: Accounting for Receivables 1.Record accounts receivable transactions. 2.Calculate the net realizable value of accounts receivable and account for bad debts. 3.Account for notes receivable. 4.Demonstrate the presentation, analysis and management of receivables. Copyright John Wiley & Sons Canada, Ltd. 9

10. Valuing Accounts Receivable Some receivables will become uncollectible –Not reported as assets if no future benefit –Net realizable value: the collectible amount Receivables are written down to their collectible amount –By recording bad debt expense –In the same period as related revenues are recorded Key issue is to estimate the amount that will not be collected Copyright John Wiley & Sons Canada, Ltd. 10

11. The Allowance Method Three features of allowance method: 1.Amount of uncollectible receivables is estimated and recorded at end of period 2.Actual uncollectibles are written off against the allowance when it is determined the specific account is uncollectible 3.If an account previously written off is recovered the write off is reversed and the collection recorded Copyright John Wiley & Sons Canada, Ltd. 11

12. Allowance for Doubtful Accounts Deducted from Accounts Receivable in the current assets section of balance sheet Net realizable value = Accounts Receivable less Allowance for Doubtful Accounts Copyright John Wiley & Sons Canada, Ltd. 12

13. Estimating the Allowance: Percentage Receivables Approach Calculates the percentage of receivables that are estimated to be uncollectible –Based on past experience and credit policy Can be applied to total receivables balance or amounts grouped by age –Requires an aging schedule to be prepared Better estimate of net realizable value Also called the balance sheet method Copyright John Wiley & Sons Canada, Ltd. 13

14. 1. Recording Estimated Uncollectibles Estimated amount of uncollectible accounts is: –Debited to an expense account – bad debts expense –Credited to a contra asset account – allowance for doubtful accounts Copyright John Wiley & Sons Canada, Ltd. 14

15. 2. Recording Write-Off of Uncollectible Accounts Amount written-off is debited to the allowance account Bad debt expense is not increased –Expense previously recognized when allowance initially recorded Copyright John Wiley & Sons Canada, Ltd. 15

16. 3. Recovery of an Uncollectible Account If cash is collected from a customer after the account has been written off: 1. Reverse write-off entry to restore customer’s account 2. Record collection of the account receivable in the usual way Copyright John Wiley & Sons Canada, Ltd. 16

17. STUDY OBJECTIVES: CHAPTER 8: Accounting for Receivables 1.Record accounts receivable transactions. 2.Calculate the net realizable value of accounts receivable and account for bad debts. 3.Account for notes receivable. 4.Demonstrate the presentation, analysis and management of receivables. Copyright John Wiley & Sons Canada, Ltd. 17

18. Notes Receivable Credit may be granted in exchange for a promissory note: –A formal credit instrument –A written promise to pay a specified amount of money on demand or at a definite time The party making the promise is the maker The party to whom payment is made is called the payee Copyright John Wiley & Sons Canada, Ltd. 18

19. Recognizing Notes Receivable If note is received to settle an outstanding account receivable: If received for cash, credit is to Cash Notes are valued at net realizable value –Similar process to determine bad debt expense and allowance as for accounts receivable Copyright John Wiley & Sons Canada, Ltd. 19

20. Recording Interest Formula for calculating interest: An annual rate of interest Separate interest receivable account is used (value of note is not altered) Copyright John Wiley & Sons Canada, Ltd. 20

21. Disposing of Notes Receivable A note is honoured when paid in full on its maturity date –Amount due is principal + interest Copyright John Wiley & Sons Canada, Ltd. 21

22. Disposing of Notes Receivable 2 A note is dishonoured if not paid in full at maturity –Note is no longer negotiable –Payee still has a valid claim against maker –Balance is transferred to Accounts Receivable in hopes of collection Copyright John Wiley & Sons Canada, Ltd. 22

23. STUDY OBJECTIVES: CHAPTER 8: Accounting for Receivables 1.Record accounts receivable transactions. 2.Calculate the net realizable value of accounts receivable and account for bad debts. 3.Account for notes receivable. 4.Demonstrate the presentation, analysis and management of receivables. Copyright John Wiley & Sons Canada, Ltd. 23

24. Statement Presentation Each major type of receivable is identified on the balance sheet or in the notes Generally reported separately in the current or noncurrent sections of the balance sheet Disclose the net amount of receivables –Gross amount and the allowance for doubtful accounts must also be disclosed, either on balance sheet or in notes Copyright John Wiley & Sons Canada, Ltd. 24

25. Analysis of Receivables Management monitors relationship between sales, receivables and cash –Receivables should increase with sales –Unusual increase could signal trouble Receivables ratios: –Used to help determine if management of receivables is helping or hurting liquidity Copyright John Wiley & Sons Canada, Ltd. 25

26. Analysis of Receivables 2 Receivables turnover ratio: = Net Credit Sales ÷ Average Receivables –Measures the number of times that receivables are collected in a period –Higher the number, the more liquid are receivables Copyright John Wiley & Sons Canada, Ltd. 26

27. Analysis of Receivables 3 Collection period: = Days in Year ÷ Receivables Turnover Ratio –Calculates the average number of days that accounts receivable are outstanding Operating Cycle: = Days Sales in Inventory + Collection Period –Calculates the number of days to complete the operating cycle Purchase of inventory through collection of cash Copyright John Wiley & Sons Canada, Ltd. 27

28. Accelerating Cash From Receivables To shorten the cash-to-cash operating cycle Loans secured by receivables: –Borrow from bank using receivables as collateral Sale of receivables: –Factoring: sell receivables to a finance company or bank (called a factor) –Securitization: sell receivables to a trust held by many investors Copyright John Wiley & Sons Canada, Ltd. 28

29. Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (the Canadian copyright licensing agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these files or programs or from the use of the information contained herein. Prepared by: A. Davis, MSc, BComm, CA, CFE Copyright Copyright John Wiley & Sons Canada, Ltd.