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Accounting The Key to Success

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					       Receivables

       C H A P T E R 10




10-1
           Accounts Receivable
  •    Arise from credit sales to customers.
  •    Often referred to as Trade Receivables.
  •    Other receivables include interest
       receivable, rent receivable, tax refund
       receivable.




10-2
        Accounts Receivable
 Companies selling on account need to:
 • Maintain a separate account for each
   customer.
 • These accounts would normally be kept in a
   sub ledger and the controlling accounting in
   the general ledger would be A/R
 • Account for bad debts (uncollectible
   accounts)

10-3
                Accounts Receivable
 Example: TechCom has the following Accounts
 Receivable balances at June 30:


            General Ledger         A/R Sub ledger
          Accounts Receivable      RDA Electronics
          bal. 3,000            bal. 1,000



       Control account
       balances with total          CompStore
       of subledger             bal. 2,000
       balances.


10-4                            Total 3,000
                Accounts Receivable
             Example: Credit sale for $950.
              Accounts Receivable- CompStore      950
                   Sales                                950

           General Ledger           A/R Sub ledger
         Accounts Receivable        RDA Electronics
         bal. 3,000               bal. 1,000
                950
         bal. 3,950
                                      CompStore
       Control account            bal. 2,000
       balances with total of
       subledger balances.               950
                                  bal. 2,950
10-5
                                 Total 3,950
               Accounts Receivable
   Example: Collection of account
        Cash                                   720
           Accounts Receivable-RDA                   720

           General Ledger         A/R Sub ledger
         Accounts Receivable      RDA Electronics
         bal. 3,000            bal. 1,000    720
               950    720      bal.   280
         bal. 3,230
                                      CompStore
       Control account          bal. 2,000
       balances with total
       of subledger                    950
       balances.                bal. 2,950
10-6
                               Total 3,230
                    Valuing Accounts Receivable
•    Some customers who are granted credit do not pay what they
    promised.
•    Even if a firm makes every effort to collect, there are always
    an expense related to non-payment
•    The accounts of these customers are called uncollectible
    accounts or bad debts.
•    The expense of bad debts is part of the cost of offering credit,
    if you only take cash, you will lose customers
•    By offering credit to a broad base of customers, you increase
    your sales
•    The cost of increasing the sales is the expense of bad debts
    on some of the accounts


    10-7
             Valuing Accounts Receivable
• The matching principle tells us that we should
  expense the bad debts in the same period as the
  sales that created them
• The conservatism principle tells that to not account
  for some possibility of bad debts overstates our
  Accounts receivable asset
• Two Methods for accounting for uncollectible
  accounts:
  1. Allowance method (satisfies GAAP)
  2. Direct method (does not satisfy GAAP)




 10-8
             1. Allowance Method
• 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.




    10-9
    Recording Estimated Bad Debt Expense
•       Adjustments for bad debts are made at
        the end of the accounting period.
•       Adjustments use a contra-asset account
        called Allowance for Doubtful Accounts.
•       When the credit balance in AFDA and
        the debit balance in A/R are combined
        on the Balance sheet, the amount shown
        is the net realizable amount of A/R


10-10
              Recording Estimated Bad Debt
               Expense - Allowance Method
• Example: The estimated bad debts for TechCom
  is $1,500. (more on how this number is determined later)
•       The period end entry to record bad debts is:
            Bad Debts Expense       1,500
              Allowance for Doubtful Accounts 1,500

An allowance account is used since we do not know
which accounts will be uncollectible.



    10-11
             Writing Off a Bad Debt - Allowance Method

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.


    10-12
              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 Receivable      Allow. For Doubtful Accts.
        bal. 20,000                                 1,500
                      520                 520
        bal. 19,480                               bal. 980


10-13
Realizable Value Before and After Write-off

        Accounts Receivable        Allow. For Doubtful Accts.
        bal. 20,000                                     1,500
                      520                  520
        bal. 19,480                                bal. 980


                                            Before         After
                                            Write-off     Write-off
  Accounts Receivable                        $20,000       $19,480
  Less: Allowance for Doubtful Accounts          1,500          980
  Est. Realizable Accounts Receivable        $18,500       $18,500

10-14                                                                 LO 2
  Recovery of a Bad Debt - Allowance Method
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.




  10-15
  Estimating Bad Debts Expense
• The company must calculate how much
 of an allowance is required prior to making
 the period ending adjustment
• Two Acceptable Methods:
1. Percent of Sales Approach
2. Accounts Receivable Approach



 10-16
    1. Percent of Sales Approach

•       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 sales.



10-17                                         LO 3
               Percent of Sales Approach

Under this approach, bad debts expense
is computed as follows:
           Current Period Sales
        x Estimated Bad Debt %
        = Estimated Bad Debts Expense




10-18
                Percent of Sales Approach

Example: MusicLand has 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:

     Bad Debts Expense                     2,400
        Allowance for Doubtful Accounts            2,400
     To record estimated bad debts



 10-19
    2. Percent of Accounts Receivable Approach

•   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:
Year-end Accounts Receivable x Bad Debt %
    • The bad debt % is determined by the business
       experience and industry norms
    • If it is not correct (it can’t be), the difference is
       picked up the next period in the adjusting entry.


    10-20
   Percent of Accounts Receivable Approach
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.




  10-21
            Aging of Accounts Receivable Approach

•   Assumes that the older the Account Receivable the
    more likely is will become uncollectible.
•   The same as % of A/R except a different and more
    accurate number is applied accounts based on age.
     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.
    10-22
        Aging of Accounts Receivable
        Example: At December 31, the receivables for
        DeCor were classified as follows:

                              DeCor
              Schedule of Accounts Receivable by Age
                            31-Dec-11
                           Accounts
                          Receivable
          Days Past Due    Balance
          Current         $   37,000
           1 - 30              6,500
          31 - 60              3,500
          61 - 90              1,900
          Over 90              1,000
                          $   49,900


10-23
         Aging of Accounts Receivable
Using estimated bad debt percentages, DeCor would
calculate the estimated uncollectible amount as follows:
                                 DeCor
                 Schedule of Accounts Receivable by Age
                                31-Dec-11
                         Accounts      Estimated    Estimated
                        Receivable    Bad Debts   Uncollectible
          Days Past Due  Balance        Percent      Amount
          Current       $    37,000           2% $         740
           1 - 30             6,500          5%          325    
          31 - 60             3,500          10%           350
          61 - 90             1,900          25%           475
          Over 90             1,000          40%           400
                        $    49,900              $       2,290


 10-24
    Aging of Accounts Receivable
DeCor’s unadjusted balance in
the allowance account is a debit   Allowance for Doubtful Accounts
                                   Unadj. bal. 200
of $200. The previous
computation shows the desired                       Adj. bal. 2,290
balance is $2,290.




 10-25
    Aging of Accounts Receivable
DeCor’s unadjusted balance in the
allowance account is a debit of  Allowance for Doubtful Accounts
                                 Unadj. bal. 200
$200. The previous computation                    Adj.      2,490
shows the desired balance is                      Adj. bal. 2,290
$2,290.
Therefore, the adjusting entry is for:
$2,290 + 200 = $2,490.




 10-26
    Aging of Accounts Receivable
DeCor’s unadjusted balance in
the allowance account is a debit    Allowance for Doubtful Accounts
                                    Unadj. bal. 200
of $200. The previous                                          2,490
computation shows the desired                        Adj. bal. 2,290
balance is $2,290. Therefore,
the adjusting entry is for:
$2,290 + 200 = $2,490.

         Bad Debts Expense                    2,490
               Allowance for Doubtful Accounts    2,490
         To record estimated bad debts


 10-27
         Direct Write-off Method
•   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.




10-28
            Writing Off a Bad Debt -
            Direct Write-off Method
        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




10-29
    Short-Term Notes Receivable
  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.


10-30
     Short-Term Notes Receivable
 •      Usually interest bearing.
 •      Interest rates are stated on an annual
        basis.
     Interest is calculated as follows:
               Principal       Annual            Time
     Interest = of the     X   interest   X   expressed
                 note            rate          in years


10-31
    Short-Term Notes Receivable
 Example: TechCom receives a $1,000, 90-
  day, 12% promissory note at the time of a
  sale.
 The entry to record the transaction would be:

        Notes Receivable      1,000
            Sales                     1,000


10-32                                     LO 4
     Short-Term Notes Receivable
Example: On December 16, TechCom receives a
 $3,000, 60-day, 12% 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




 10-33
            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          14.79
         Interest Revenue                       14.79
      (3,000 x 12% x 15/365)
     On February 14, the 60-day note matures.
     The entry to record the honouring of the note would be:
     Cash                         3,059.18
          Interest Revenue                       44.39
          Interest Receivable                    14.79
          Notes Receivable                    3,000.00
      (3,000 x 12% x 60/365)= 59.18
    10-34
          Using the Information Appendix 10B


• 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




  10-35
        Using the Information Appendix 10B



                                         Net Sales
Accounts receivable turnover =
                                 Average accounts receivable



Days’ sales            Accounts receivable
              =                                  x 365
Uncollected
                            Net sales




10-36