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Chapter 8

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Chapter 8Reporting and Analyzing ReceivablesAfter studying Chapter 8, you should be able to:

Identify the different types of receivables.Explain how accounts receivable are recognized in

the accounts.Describe the methods used to account for bad

debts.Compute the interest on notes receivable.Describe the entries to record the disposition of

notes receivable.

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Chapter 8Reporting and Analyzing ReceivablesAfter studying Chapter 8, you should be able to:

Explain the statement presentation of receivables.

Describe the principles of sound accounts receivable management.

Identify ratios to analyze a company's receivables.

Describe methods to accelerate the receipt of cash from receivables.

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Receivables...Amounts due from individuals and

companies - expected to be collected in cash.

Frequently classified as: Accounts receivable Notes receivable Other receivables

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Receivables Differ Depending On...

IndustryTime of yearWhether the company extends

long-term financingCredit policies

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Accounts Receivable...

Amounts owed by customers on account.

Result from the sale of goods/services.

Expected to be collected within 30-60 days.

Most significant type of claim held by company.

Often called trade receivables.

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Accounts Receivable...

Are recorded when service is provided or at point of sale of merchandise on account.

Accounts Receivable 100 Sales 100

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Problems with Accounts Receivable

Recognizing accounts receivable.Valuing accounts receivable.

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Accounts Receivables...

Are reduced as a result of:•Cash rceipts•Sales discounts•Sales returns and allowances

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Other ReceivablesNotes receivable from customers

Nontrade receivables including: interest receivableloans to company officersadvances to employeesincome taxes refundable

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Bad Debts Expense...

Is an expense to record estimated uncollectible receivables.

Keeps expenses from being understatedon the income statement and accounts receivable from being overstated on the balance sheet.

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2 Methods for Accounting for Uncollectible Accounts

The Direct Write-off Method (Not GAAP)

The Allowance Method

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Direct Write-off Method

Bad debt losses are not estimated.No allowance account is used.Accounts are written off when

determined uncollectible as follows:

Bad Debts Expense 200

Accounts Receivable--M. E. Doran 200

Bad debt expense will show only actual losses.Accounts receivable will be reported at gross amount.

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Direct Write-off Method Issue

No attempt is made to match bad debts expense to sales revenue; therefore, this method is not acceptable under GAAP.

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Allowance Method

Uncollectible accounts receivable are estimated and matched against sales in the same accounting period in which the sales occurred.

Uncollectible accounts receivable may be estimated using: Percentage of sales Aging of accounts receivable

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Recording Estimated Uncollectibles

Hampton Furniture has credit sales of $1,200,000, of which $200,000 remains uncollected. The credit manager estimates $12,000 will prove uncollectible.

Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000

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Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000

Accounts ReceivableAllowance for

Doubtful Accounts

Jan 1 Bal 200,000 Jan 1 Bal 12,000

Recording Estimated Uncollectibles

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Is the net amount expected to be collected in cash.

Excludes amounts the company estimates it will not collect.

Cash (Net) Realizable Value

Keeps receivables from being overstatedon the balance sheet.

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HAMPTON FURNITUREBalance Sheet (partial)

Current assets Cash $ 14,800

Accounts receivable $200,000Less: Allowance for doubtful accounts 12,000 188,000

Cash (net) Realizable Value

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HAMPTON FURNITUREBalance Sheet (partial)

Current assets Cash $ 14,800

Accounts receivable $200,000Less: Allowance for doubtful accounts 12,000 188,000Merchandise Inventory 310,000

Prepaid Expense 25,000Total current assets $537,800

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The vice president of finance authorizes a write-off of $500 owed by R.A. Ware.

Allowance for Doubtful Accounts 500

Accounts Receivable-Ware 500

Write-off of an Uncollectible Account

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Write-off of an Uncollectible Account

Allowance for Doubtful Accounts 500

Accounts Receivable-Ware 500

Accounts ReceivableAllowance for

Doubtful Accounts

Jan 1 Bal 200,000 Mar 1 500

Mar 1 Bal 199,500

Jan 1 Bal 12,000Mar 1 500

Mar 1 Bal 11,500

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Current assets Cash $ 14,800

Accounts receivable $200,000Less: Allowance for doubtful accounts 12,000 188,000

Current assets Cash $

14,800Accounts receivable $199,500Less: Allowance for doubtful accounts 11,500 188,000

Before Write-off

After Write-off

Cash Realizable Value

Cash Realizable Value

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Recovery of an Uncollectible Account

Accounts Receivable-Ware 500 Allowance for Doubtful

Accounts 500

Cash 500 Accounts Receivable 500

OR Cash 500

Allowance for Doubtful Accounts 500

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Percentage of Receivables... Management establishes a

percentage relationship between the amount of receivables and the expected losses from uncollectible accounts based on historical loss experience

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Aging of Accounts Receivable

The analysis of customer balances by the length of time they have been unpaid. The longer a debt is outstanding the less likely it is to be paid.

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Credit instrument normally requires:

payment of interest extends for time periods of 60-90

days or longer.

Notes Receivable...

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Notes Receivable...Are often accepted from

customers who need to extend payment of an account receivable.

Are often required from high-risk customers.

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Represent claims for which formal instruments of credit are issued as evidence of debt.

Notes Receivable...

2004

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Maker

Is the party in a promissory note who is making the promise to pay.

Payee

Is the party to whom payment of a promissory note is to be made.

Payee

Is the party to whom payment of a promissory note is to be made.

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Formula for Interest

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Interest rate specified on a note is an annual rate of interest. Prorate for shorter times periods.

1,000 x .12 x 12 months/12months1,000 x .12 x 1 month/12months1,000 x .12 x 3 months/12months1,000 x .12 x 6 months/12months1,000 x .12 x 9 months/12months

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Interest rate specified on a note is an annual rate of interest.

Time factor is often divided by 360 days1,000 x .12 x 360 days/360 days 1,000 x .12 x 27 days/360 days1,000 x .12 x 46 days/360 days1,000 x .12 x 162 days/360 days1,000 x .12 x 265 days/360 days

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Notes Receivable...

are recorded at face value.

are reported at cash (net) realizable value.

are honored when paid in full at maturity.

are dishonored when not paid in full at maturity.

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Notes Receivable...Interest revenue is recorded

when the note is paid. If interim financial statements

are prepared, interest on notes receivable is accrued.

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Notes Receivable...Each type of receivables should be

identified in the balance sheet or in the notes to the financial statements.

Short-term receivables are reported in the current asset section of the balance sheet below short-term investments.

The gross amount of receivables and the allowance for doubtful accounts should be reported.

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Notes Receivable...Notes receivable are listed

before accounts receivable because notes are more easily converted to cash.

Bad debts expense is reported as a selling expense in the income statement.

Interest revenue is shown under other revenues and gains in the nonoperating section of the income statement.

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Managing ReceivablesDetermine to whom to extend credit.Establish a payment period.Monitor collections.Evaluate receivables balance.Accelerate cash receipts from

receivables when necessary.

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Extending CreditRisky customers might be required

to provide letters of credit or bank guarantees.

Risky customers might be required to pay cash on delivery (COD).

Ask potential customers for references from banks and suppliers and check the references.

Periodically check financial health of continuing customers.

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Payment PeriodDetermine a required payment

period and communicate that policy to customers.

Make sure company's payment period is consistent with that of competitors.

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Monitoring Collections

Calculate company’s credit risk ratio.

Prepare accounts receivable aging schedule at least monthly.

Pursue problem accounts with: phone calls letters legal action if

necessary.

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Concentration of Credit Risk

Is there a threat of nonpayment from a single customer or class of customers that could adversely affect the financial health of the company?

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Evaluating the Receivables Balance

Liquidity is measured by how quickly certain assets can be converted into cash.

The receivables turnover ratio measures the number of times, on average, receivables are collected during the period.

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Receivables Turnover Ratio=

Net Credit SalesAverage Net Receivables

Is a measure of the liquidity of receivables.

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Average Collection Period=

365 daysReceivables Turnover Ratio

Is the average amount of time that a receivable is outstanding

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Accelerating Cash Receipts

Waiting for the normal collection process costs

money.

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Companies Sell ReceivablesThey get more sales if they provide

financing to customers. General Motors Acceptance Corporation Ford Motor Credit Corporation

They may be the only reasonable source of cash.

Billing and collection are often time-consuming and costly.

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Factor...

Is a finance company or bank that buys receivables from businesses for a fee and then collects payments directly from the customers.

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Expense Associated with Selling Receivables

If a company usually sells its receivables, the service charge expense is recorded as a selling expense.

However, if receivables are sold infrequently the fee may be reported under other expenses and losses in the income statement.

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Credit Card

Three parties are involved when national credit cards are used in making retail sales:

the credit card issuerthe retailerthe customer

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Bank Credit Card

Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer.

Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller's bank balance.

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Advantages of Credit Cards to the Retailer

Issuer does credit investigation of customer

Issuer maintains customer accounts

Issuer takes collection action and absorbs credit losses

Retailer receives cash sooner