nobles fin5 ppt_08

Chapter 8Receivables

Learning Objectives

1. Define and explain common types of receivables and journalize sales on credit, credit card sales, and debit card sales

2. Apply the direct write-off method for uncollectibles

Learning Objectives

3. Apply the allowance method for uncollectibles and estimate bad debts expense based on the percent-of-sales, percent-of-receivables, and aging-of-receivables methods

Learning Objectives

4. Account for notes receivable including computing interest and recording honored and dishonored notes

5. Use the acid-test ratio, accounts receivable turnover ratio, and days’ sales in receivables to evaluate business performance

Learning Objective 1

Define and explain common types of receivables and journalize sales on credit, credit card sales, and debit card sales

What Are Common Types of Receivables, and How Are Credit Sales Recorded?

• A receivable occurs when a business sells goods or services to another party on account (on credit).

• A receivable is a monetary claim against a business or an individual.– A receivable is a right to receive cash in the

future from a current transaction. – A creditor is the party who receives a receivable.– A debtor is the party to a credit transaction who

is obligated to pay later.

Accounts Receivable

• Accounts receivable, also called trade receivables, represents the right to receive cash in the future from customers for goods or services performed. – Generally collected within 30 to 60 days– Reported as a current asset on the balance

Notes Receivable

• Notes receivable usually have longer terms than accounts receivable. • Notes receivable are sometimes called

promissory notes.• A note receivable represents a promise to pay

a fixed amount of principle plus interest by a certain due date.

• The maturity date is the date on which a note receivable is due.

Other Receivables

• Any other type of receivable is considered other receivables.

• Receivables are classified as either current or long-term, depending on whether they will be received in one year or less.

• Examples include:• Dividends receivable• Interest receivable• Taxes receivable

Recording Sales on Credit

• Smart Touch Learning performs $5,000 in services to Brown on account and sells $10,000 (sales price) of merchandise inventory to customer Smith on account on August 8. Ignore Cost of Goods Sold.

Recording Sales on Credit• The control account, Accounts Receivable,

shows a balance of $15,000. The individual customer accounts in the subsidiary ledger (Accounts Receivable—Brown $5,000 + Accounts Receivable—Smith $10,000) add up to $15,000.

Recording Sales on Credit

• When the business collects cash from both customers on August 29—$4,000 from Brown and $8,000 from Smith—Smart Touch Learning makes the following entry:

Recording Credit Card and Debit Card Sales

• Credit and debit card sales are recorded the same as cash sales.

• A fee is usually charged by the card company.

• There are two methods for recording credit card sales:– Net method– Gross method

• Smart Touch Learning sells merchandise inventory (ignore Cost of Goods Sold) to a customer for $3,000. The customer pays with a third-party credit card. The card processor assesses a 4% fee. Use the net method.

• Smart Touch Learning sells merchandise inventory (ignore Cost of Goods Sold) to a customer for $3,000. The customer pays with a third-party credit card. The card processor assesses a 4% fee. Use the gross method.

• At the end of August, the process collects the fee assessed for the month.

Apply the direct write-off method for uncollectibles

How Are Uncollectibles Accounted for When Using the Direct Write-Off Method?

• Bad debts expense arises from failure to collect from some customers who purchase on account.

• There are two methods of accounting for uncollectible receivables:– Direct write-off method– Allowance method (required by GAAP)

Recording and Writing Off Uncollectible Accounts—Direct Write-off Method

• The direct write-off method of accounting for uncollectible receivables is primarily used by small, nonpublic companies.– Accounts receivable are written off when the

business determines that it will never collect from a specific customer.

– Bad debts expense is recorded.

• On August 9, Smart Touch Learning determines that it will not be able to collect $200 from customer Dan King for a sale of merchandise inventory made on May 5.

• Sometimes customers make payments after the company writes off the account. – To account for this recovery, the company must

reverse the earlier write-off.– Then it records the receipt of the payment.

Apply the allowance method for uncollectibles and estimate bad debts expense based on the percent-of-sales, percent-of-receivables, and aging-of-receivables methods

How Are Uncollectibles Accounted for When Using the Allowance Method?

• Most companies use the allowance method to measure bad debts.– The allowance method is based on the

matching principle. – It records bad debts in the same period as the

sales revenue.

• A contra asset account called Allowance for Bad Debts reduces the Accounts Receivable to the net realizable value.

Recording Bad Debts Expense—Allowance Method

• As of December 31, 2017, Smart Touch Learning estimates that $80 of its $4,400 accounts receivable are uncollectible.

Recording Bad Debts Expense—Allowance Method

Writing Off Uncollectible Accounts—Allowance Method

• An allowance is established for the estimated uncollectible accounts.

• Instead of recording a debit to Bad Debts Expense, the company records a debit to Allowance for Bad Debts.

• The entry to write off an account under the allowance method has no effect on net income at the time of entry.

Writing Off Uncollectible Accounts—Allowance Method

• On January 10, 2018, Smart Touch Learning determines that it cannot collect a total of $25 from its customer Shawn Clark.

Recovery of Accounts Previously Written Off—Allowance Method

• Recall that Smart Touch Learning wrote off the $25 receivable from Shawn Clark on January 10, 2018. It is now March 4, 2018, and Smart Touch Learning unexpectedly receives $25 cash from Clark.

Estimating and Recording Bad Debts Expense—Allowance Method

• Companies estimate bad debts expense based upon:• Past experience• The industry in which they operate• Other variables

• There are three methods to estimate uncollectibles using the allowance method:– Percent-of-sales– Percent-of-receivables– Aging-of-receivables

• The percent-of-sales method computes bad debts expense as a percentage of net credit sales.

• Some companies use all sales, not just credit sales.

• This method is also called the income-statement approach.

Percent-of-Sales Method

• Smart Touch Learning uses the percent-of-sales method to account for uncollectibles. Past experience suggests that 0.5% of credit sales will be uncollectible, which amounted to $60,000.

Percent-of-Sales Method

Percent-of-Receivables Method

• The percent-of-receivables method computes bad debts expense as a percentage of accounts receivable.

Percent-of-Receivables Method

• Assume on December 31, 2018, Smart Touch Learning’s unadjusted Accounts Receivable balance is $6,375, and 4% of the accounts receivable is estimated to be uncollectible. The Allowance for Bad Debts account currently has a credit balance of $55, so the adjustment in only $200.

Aging-of-Receivables Method

• The aging-of-receivables method is similar to the percent-of-receivables method.

• In the aging method, businesses group individual accounts based on how long the receivable has been outstanding.

• Different percentages are applied to each category.

• The target balance of the Allowance for Bad Debts account is $185.

Comparison of Accounting for Uncollectibles

Account for notes receivable including computing interest and recording honored and dishonored notes

How Are Notes Receivable Accounted For?

Notes receivable

Debtor

Interest

Interest rate

Maturity

Maturity date

• Smart Touch Learning lends Lauren Holland $1,000 on September 30, 2017, for one year, at an annual rate of 6%.

Computing Interest on a Note

• Interest is recorded based on the amount of time that has passed:

• Interest rates are always annual.• Time is always a fraction of a year.

Accruing Interest Revenue and Recording Honored Notes Receivable

• December 31: The $1,000 loan to Lauren Holland is not yet due, but interest must be accrued at a rate of 6%.

Accruing Interest Revenue and Recording Honored Notes Receivable

• Smart Touch Learning earns nine months (January through September) of interest, which is $1,000 × 0.06 × 9/12 = $45.

Recording Dishonored Notes Receivable

• When a maker dishonors a note, the dishonored note and the unpaid interest are transferred to Accounts Receivable.

• Later, the Accounts Receivable can be written off under the direct write-off method or the allowance method.

• Suppose Rubinstein Jewelers has a six-month, 10% note receivable for $1,200 from Mark Adair that was signed on March 3, 2017, and Adair defaults.

Recording Dishonored Notes Receivable

Use the acid-test ratio, accounts receivable turnover ratio, and days’ sales in receivables to evaluate business performance

How Do We Use the Acid-Test Ratio, Accounts Receivable Turnover Ratio, and Days’ Sales in

Receivables to Evaluate Business Performance?

• Balance-sheet data are useful because they show the relationships among assets, liabilities, and revenues.

• Ratios for analysis:– Acid-test ratio– Accounts receivable turnover ratio– Days’ sales in receivables

Acid-Test (or Quick) Ratio

• The acid-test ratio is used to measure a company’s ability to pay its current liabilities.

• It is more stringent than the current ratio. • Quick assets are cash, cash equivalents,

short-term investments, and net current receivables.

Accounts Receivable Turnover Ratio

• The accounts receivable turnover ratio measures the number of times the company collects the average accounts receivable balance in a year.

• The higher the ratio, the faster the cash collections.

Days’ Sales in Receivables

• Days’ sales in receivables indicates how many days it takes to collect the average level of accounts receivable. It is also called the collection period.

nobles fin5 ppt_08

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