1. Receivables PowerPoint Slides to accompany Fundamental Accounting Principles, 14ce Prepared by Joe Pidutti, Durham College CHAPTER 9 © 2013 McGraw-Hill Ryerson Limited.

2. 1. Describe accounts receivable and how they occur and are recorded. (LO 1 ) 2. Apply the allowance method to account for uncollectible accounts receivable. (LO 2 ) 3. Estimate uncollectible accounts receivable using approaches based on sales and accounts receivable. (LO 3 ) 2 © 2013 McGraw-Hill Ryerson Limited. Learning Objectives

3. 4. Describe and record a short-term note receivable and calculate its maturity date and interest. (LO 4 ) 5. Explain how receivables can be converted to cash before maturity. (Appendix 9A) (LO 5 ) 6. Calculate accounts receivable turnover and days’ sales uncollected to analyze liquidity. (Appendix 9B) (LO 6 ) 3 © 2013 McGraw-Hill Ryerson Limited. Learning Objectives

4. Arise from credit sales to customers. Often referred to as Trade Receivables. Other receivables include interest receivable, rent receivable, tax refund receivable. 4 © 2013 McGraw-Hill Ryerson Limited. Accounts Receivable LO 1

5. Companies selling on account need to: Maintain a separate account for each customer. Account for bad debts. 5 © 2013 McGraw-Hill Ryerson Limited. Accounts Receivable LO 1

6. Example: TechCom has the following Accounts Receivable balances at June 30: 6 © 2013 McGraw-Hill Ryerson Limited. General Ledger A/R Subledger Accounts Receivable RDA Electronics bal. 3,000bal. 1,000 CompStore bal. 2,000 Total 3,000 Control account balances with total of subledger balances. Accounts Receivable LO 1

7. General Ledger A/R Subledger Accounts Receivable RDA Electronics bal. 3,000bal. 1,000 950 bal. 3,950 CompStore bal. 2,000 950 bal. 2,950 Total 3,950 Control account balances with total of subledger balances. Example: Credit sale for $950. Accounts Receivable- CompStore 950 Sales 950 7 © 2013 McGraw-Hill Ryerson Limited. Accounts Receivable LO 1

8. General Ledger A/R Subledger Accounts Receivable RDA Electronics bal. 3,000bal. 1,000 720 950 720 bal. 280 bal. 3,230 CompStore bal. 2,000 950 bal. 2,950 Total 3,230 Control account balances with total of subledger balances. Example: Collection of account Cash 720 Accounts Receivable-RDA 720 8 © 2013 McGraw-Hill Ryerson Limited. Accounts Receivable LO 1

9. Some customers who are granted credit do not pay what they promised. The accounts of these customers are called uncollectible accounts or bad debts. 9 © 2013 McGraw-Hill Ryerson Limited. Valuing Accounts Receivable LO 1

10. Methods for accounting for uncollectible accounts: 1. Direct method (does not satisfy GAAP) 2. Allowance method (satisfies GAAP) a) Income statement approach (percent of sales) b) Balance sheet approach (calculates the required balance in AFDA) 10 © 2013 McGraw-Hill Ryerson Limited. Valuing Accounts Receivable LO 2

11. The matching principle requires that bad debts expense be matched and reported in the same period as the sale that generated the receivable. The allowance method satisfies the matching principle by matching expected bad debts losses (expenses) with revenues that produced the losses. 11 © 2013 McGraw-Hill Ryerson Limited. Allowance Method LO 2

12. Adjustments for bad debts are made at the end of the accounting period. Adjustments use a contra-asset account called Allowance for Doubtful Accounts. 12 © 2013 McGraw-Hill Ryerson Limited. Recording Estimated Bad Debt Expense LO 2

13. Example: The estimated bad debts for TechCom is $1,500. The period end entry to record bad debts is: Bad Debts Expense1,500 Allowance for Doubtful Accounts 1,500 An allowance account is used since we do not know which accounts will be uncollectible. 13 © 2013 McGraw-Hill Ryerson Limited. Recording Estimated Bad Debt Expense - Allowance Method LO 2

14. Example: A specific customer’s account (Jack Kent) is considered uncollectible. The entry to record the write-off is: Allowance for Doubtful Accounts 520 Accounts Receivable - Jack Kent 520 Note that there is no expense recorded when the account is written off. The estimated expense was previously recorded. 14 © 2013 McGraw-Hill Ryerson Limited. Writing Off a Bad Debt - Allowance Method LO 2

15. General Ledger Balances Bad Debts Expense 1,500 Allowance for Doubtful Accounts 1,500 To record estimated bad debts Allowance for Doubtful Accounts 520 Accounts Receivable - Jack Kent 520 To write off an uncollectible account Accounts ReceivableAllow. For Doubtful Accts. bal. 20,000 1,500 520 520 bal. 19,480bal. 980 15 © 2013 McGraw-Hill Ryerson Limited. LO 2

16. 16 © 2013 McGraw-Hill Ryerson Limited. Realizable Value Before and After Write-off Before Write-off After Write-off Accounts Receivable$20,000$19,480 Less: Allowance for Doubtful Accounts1,500980 Est. Realizable Accounts Receivable$18,500 Accounts ReceivableAllow. For Doubtful Accts. bal. 20,000 1,500 520 520 bal. 19,480bal. 980 LO 2

17. Example: Jack Kent pays his account in full after the account had been written off. Entries are needed to record the reinstatement of the account and the subsequent collection. The entries are: Accounts Receivable-Jack Kent 520 Allowance for Doubtful Accounts 520 To reinstate customer’s account. Cash 520 Accounts Receivable-Jack Kent 520 To record collection of account. 17 © 2013 McGraw-Hill Ryerson Limited. Recovery of a Bad Debt- Allowance Method LO 2

18. Acceptable Methods: 1. Percent of Sales Approach 2. Accounts Receivable Approach 18 © 2013 McGraw-Hill Ryerson Limited. Estimating Bad Debts Expense LO 3

19. Also referred to as the Income Statement Approach. Based on idea that a percentage of a company’s credit sales are uncollectible. The primary focus is on matching bad debts expense with credit sales. 19 © 2013 McGraw-Hill Ryerson Limited. Percent of Sales Approach LO 3

20. Current Period Sales x Estimated Bad Debt % = Estimated Bad Debts Expense Percent of Sales Approach 20 © 2013 McGraw-Hill Ryerson Limited. Under this approach, bad debts expense is computed as follows: LO 3

21. Example: MusicLand has credit sales of $400,000 and estimates 0.6% of those sales will not be collectible. Estimated Bad Debts Expense is calculated as $2,400 ($400,000 x.6%). The period end adjusting entry would be: Percent of Sales Approach 21 © 2013 McGraw-Hill Ryerson Limited. Bad Debts Expense 2,400 Allowance for Doubtful Accounts 2,400 To record estimated bad debts LO 3

22. This method assumes that a percentage of Accounts Receivable is uncollectible. Using this method, we compute the estimate of the Allowance for Doubtful Accounts as: 22 © 2013 McGraw-Hill Ryerson Limited. Year-end Accounts Receivable x Est. Bad Debt % Percent of Accounts Receivable Approach LO 3

23. Percent of Accounts Receivable Approach 23 © 2013 McGraw-Hill Ryerson Limited. Bad Debts Expense is computed as: Estimated adjusted balance in Allowance for Doubtful Accounts - Unadjusted year-end balance in Allowance for Doubtful Accounts = Estimated Bad Debts Expense The objective for the entry is to make the Allowance account balance equal to the portion of outstanding Accounts Receivable estimated to be uncollectible. LO 3

24. Assumes that the older the Account Receivable the more likely is will become uncollectible. Steps: 1. Group accounts based on how much time has passed since they were created. 2. Estimate rates of uncollectibility for each group. 3. Apply rate to each group to get the required balance for the Allowance account. 24 © 2013 McGraw-Hill Ryerson Limited. Aging of Accounts Receivable Approach LO 3

25. Example: At December 31, the receivables for DeCor were classified as follows: Aging of Accounts Receivable 25 © 2013 McGraw-Hill Ryerson Limited. LO 3

26. Using estimated bad debt percentages, DeCor would calculate the estimated uncollectible amount as follows: Aging of Accounts Receivable 26 © 2013 McGraw-Hill Ryerson Limited.    LO 3

27. Allowance for Doubtful Accounts Unadj. bal. 200 Adj. bal. 2,290 DeCor’s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290. Aging of Accounts Receivable 27 © 2013 McGraw-Hill Ryerson Limited. LO 3

28. DeCor’s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290. Therefore, the adjusting entry is for: $2,290 + 200 = $2,490. Aging of Accounts Receivable 28 © 2013 McGraw-Hill Ryerson Limited. Allowance for Doubtful Accounts Unadj. bal. 200 Adj. 2,490 Adj. bal. 2,290 LO 3

29. DeCor’s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290. Therefore, the adjusting entry is for: $2,290 + 200 = $2,490. Aging of Accounts Receivable 29 © 2013 McGraw-Hill Ryerson Limited. Bad Debts Expense 2,490 Allowance for Doubtful Accounts 2,490 To record estimated bad debts Allowance for Doubtful Accounts Unadj. bal. 200 2,490 Adj. bal. 2,290 LO 3

30. Sometimes used as an alternative to the Allowance method when uncollectible accounts are not material. The loss from an uncollectible account is recorded when it is determined to be uncollectible. This method does not satisfy the principles of prudence and matching. 30 © 2013 McGraw-Hill Ryerson Limited. Direct Write-off Method LO 3

31. Example: A specific customer’s account (Jack Kent) is considered uncollectible. The entry to record the write-off is: Bad Debts Expense 520 Accounts Receivable—Jack Kent 520 31 © 2013 McGraw-Hill Ryerson Limited. Writing Off a Bad Debt - Direct Write-off Method LO 3

32. On October 29, 2014, TC Co. concluded that a customer's $4,400 account receivable was uncollectible and that the account should be written off. What effect will this write-off have on TC Co.’s 2014 net income and balance sheet totals assuming the allowance method is used to account for bad debts? A)Decrease in net income; no effect on total assets. B)No effect on net income or on total assets. C)Decrease in net income; decrease in total assets. D)Increase in net income; no effect on total assets. E)No effect on net income; decrease in total assets. 32 © 2013 McGraw-Hill Ryerson Limited. Mini-Quiz

33. On October 29, 2014, TC Co. concluded that a customer's $4,400 account receivable was uncollectible and that the account should be written off. What effect will this write-off have on TC Co.’s 2014 net income and balance sheet totals assuming the allowance method is used to account for bad debts? A)Decrease in net income; no effect on total assets. B)No effect on net income or on total assets. C)Decrease in net income; decrease in total assets. D)Increase in net income; no effect on total assets. E)No effect on net income; decrease in total assets. 33 © 2013 McGraw-Hill Ryerson Limited. ADA4,400 A/R 4,400 Mini-Quiz

34. Promissory Note A written promise to pay a specified amount of money either on demand or at a definite future date. Short-Term Note Receivable A promissory note that becomes due within 12 months or within the firm’s operating cycle. 34 © 2013 McGraw-Hill Ryerson Limited. Short-Term Notes Receivable LO 4

35. Usually interest bearing. Interest rates are stated on an annual basis. Interest is calculated as follows: 35 © 2013 McGraw-Hill Ryerson Limited. Interest = Principal of the note Annual interest rate Time expressed in years XX Short-Term Notes Receivable LO 4 or I=Prt

36. Short-Term Notes Receivable Example: TechCom receives a $1,000, 90- day, 6% promissory note at the time of a sale. The entry to record the transaction would be: Notes Receivable 1,000 Sales 1,000 36 © 2013 McGraw-Hill Ryerson Limited. LO 4

37. Short-Term Notes Receivable Example: On December 16, TechCom receives a $3,000, 60-day, 6% promissory note and $1,000 cash to settle a $4,000 past due account. The entry to record the transaction would be: Cash 1,000 Notes Receivable 3,000 Accounts Receivable 4,000 37 © 2013 McGraw-Hill Ryerson Limited. LO 4

38. Short-Term Notes Receivable On December 31, 15 days after the note is issued, an accrual for interest earned on the note is made. The entry to record the accrual would be: Interest Receivable 7.40 Interest Revenue 7.40 (3,000 x 6% x 15/365) On February 14, the 60-day note matures. The entry to record the honouring of the note would be: Cash 3,029.59 Interest Revenue 22.19 Interest Receivable 7.40 Notes Receivable 3,000.00 (3,000 x 6% x 60/365)= 29.59 38 © 2013 McGraw-Hill Ryerson Limited. LO 4

39. Short-Term Notes Receivable Sometimes the maker of a note does not pay the note at maturity. This is known as dishonouring the note. The payee should use every legitimate means to collect. If the note was made to replace an AR then it should be removed from Notes Receivable and reinstated as an Account Receivable. 39 © 2013 McGraw-Hill Ryerson Limited. LO 4

40. Review Explain why the allowance method satisfies the generally accepted principles of prudence and matching. The allowance method ensures that the asset, accounts receivable, and the reported net income are not overstated. In this way it accomplishes the requirements of the prudence principle. The allowance method recognizes the bad debts expense in the same period in which the related credit sales were recognized. In this way it accomplishes the required matching of expenses with the period in which the revenue was recognized. 40 © 2013 McGraw-Hill Ryerson Limited.

41. Review Explain how to record the receipt of a note receivable. A note is recorded by entering the total amount borrowed (principal) as a debit to Notes Receivable and as a credit to the account representing the asset or service exchanged for the note. 41 © 2013 McGraw-Hill Ryerson Limited.

42. Receivables are sometimes converted into cash before maturity since: 1. Companies may need the cash. 2. Companies do not want to be involved in the collection activities. 42 © 2013 McGraw-Hill Ryerson Limited. Converting Receivables to Cash Before Maturity- Appendix 9A LO 5

43. Conversion of receivables into cash is accomplished by either: 1. Selling them to a factor 2. Pledging them as loan security. 43 © 2013 McGraw-Hill Ryerson Limited. LO 5 Converting Receivables to Cash Before Maturity- Appendix 9A

44. The quality (likelihood of collection) and liquidity (speed of collection) of a company’s receivables may be assessed by calculating: 1. Accounts receivable turnover ratio 2. Days’ sales uncollected Using the Information Appendix 9B 44 © 2013 McGraw-Hill Ryerson Limited. LO 6

45. Accounts receivable turnover = Net Sales Average accounts receivable Days’ sales Uncollected = Accounts receivable Net sales x 365 45 © 2013 McGraw-Hill Ryerson Limited. LO 6 Using the Information Appendix 9B

46. End of Chapter 46 © 2013 McGraw-Hill Ryerson Limited.