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Receivables

Chapter 9

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Accountsreceivable

Receivables

Notes receivable

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Design internal controls

for receivables.

Objective 1

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Establishing Internal Control

What are some controls over accounts

receivable?

Separation

of duties

Approval for

write-off

Control over

mail receipts

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Use the allowance method

to account for uncollectiblesand estimate uncollectibles

by the percent of sales

and aging approaches.

Objective 2

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The Credit Department

Companies grant credit to customers in

order to increase sales.

The credit department evaluates customerswho apply for credit cards.

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Uncollectible Accounts Expense

Allowance method

Directwrite-off method

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Methods for Estimating

Uncollectible Expense

Percentage of Sales

Aging of Receivables

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Percentage of Sales

This is also called the income statement

approach.

It is based on prior experience of the business. It is computed as a percentage ofcreditsales.

It ignores the current balance of the allowance

account.The percentage used is adjusted as needed to

reflect collection experience.

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Percentage of Sales Example

The credit department of Anas Boutique

estimates (based on prior experience) that

1% of net credit sales are uncollectible.Net credit sales for the year just ended

were $500,000.

What is the adjusting entry?$500,000 1% = $5,000

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Percentage of Sales Example

Dec 31, 20xx

Uncollectible Account Expense 5,000

Allowance for Uncollectible Accounts 5,000

Recorded expense for the year

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Decrease inNet Income Decrease in netAccounts Receivable

What is the effect of this adjusting entry?

Percentage of Sales Example

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Aging of Accounts Receivable

This approach is also called the balance

sheetapproachbecause it focuses onaccounts receivable.

Individual accounts receivable from specific

customers are analyzed according to the

length of time they remain outstanding.

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Aging of Receivables Example

Assume that International Hospitals

past collection experience indicates the

following:Length of time % uncollectible

1-30 days 2.0

31-60 days 3.061-90 days 5.0

90 + days 8.0

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Accounts

Receivable

Allowance for

Uncollectible Accounts

Length Amount %

1-30 $1,900,000 2 $ 38,000

31-60 1,000,000 3 30,00061-90 700,000 5 35,000

90 + 500,000 8 40,000

Total $4,100,000 $143,000

Aging of Receivables Example

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Aging of Receivables Example

The allowance account is adjusted to this

$143,000 balance:

Assume that the account currently has acredit balance of $100,000.

What is the adjustment?

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Uncollectible Account

Expense 43,000

Allowance for Uncollectible

Accounts 43,000

To record allowance for uncollectibles

What if the account had a

debit balance of $1,000?

Aging of Receivables

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Allowance for Uncollectible

Adjustment1,000 144,000

Adjusted balance 143,000

Aging of Receivables

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Comparing the Percentage of Sales

and Aging Methods

Allowance Method

Percent of Sales Method Aging of Accounts Receivable Method

Adjusts Allowance for

Uncollectible Accounts

Adjusts Allowance for

Uncollectible Accounts

BY TO

UNCOLLECTIBLE

ACCOUNT EXPENSEUNCOLLECTIBLE

ACCOUNTS RECEIVABLE

Amount of Amount of

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Writing Off

Uncollectible AccountsWhat happens when it becomes apparent

that an account will not be collected?

It must be written off.How?

Debit Allowance for Uncollectible

Accounts.Credit Accounts Receivable.

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Recoveries

How is the collection of a previously written-

off account recorded?

Debit Accounts Receivable (to reinstate theaccount).

Credit Allowance for Uncollectible Accounts.

Debit Cash.

Credit Accounts Receivable (to record the

collection).

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Use the direct write-off method

to account for uncollectibles.

Objective 3

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Direct Write-Off Method

Using this method, an account is written

off only when it becomes uncollectible.

No allowance account is created.This method is simple to use.

The balance sheet is overstated.

The income statement is understated.

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Credit Card and Bankcard Sales

These save retailers the cost of a credit

department.

The retailer is required to pay a fee(called a discount) for usage.

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Credit Card and Bankcard Sales

How would Anas Boutique record a $100

credit card sale with a 2% service charge?

Accounts Receivable (credit card) 98

Credit Card Discount 2

Sales Revenue 100

To record a credit card sale of $100

less a 2% service charge fee

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Debit Card Sales

Using a debit card is like

paying with cash.

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Notes Receivable: an Overview

A note receivable may arise from a sale or

may be given in settlement of an account

receivable.The maker pays the payee the maturity

value.

The maturity value includes principal plusinterest.

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Promissory Note

$10,000.00 Nov. 30, 2004

For value received, I promise to pay to the order of

POPULAR BANK

HOUSTON, TEXAS

TEN THOUSAND AND NO/100DOLLARS

ON FEBRUARY 28, 2005

Plus interest at the annual rate of 10 percent.

__________

Payee

Notes Receivable: an Overview

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Promissory Note

$10,000.00 Nov. 30, 20x4

For value received, I promise to pay to the order of

POPULAR BANK

HOUSTON, TEXAS

TEN THOUSAND AND NO/100DOLLARS

ON FEBRUARY 28, 20x5Plus interest at the annual rate of 10 percent.

__________Principal

Notes Receivable: an Overview

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Promissory Note

$10,000.00 Nov. 30, 20x4

For value received, I promise to pay to the order of

POPULAR BANK

HOUSTON, TEXAS

TEN THOUSAND AND NO/100DOLLARS

ON FEBRUARY 28, 20x5Plus interest at the annual rate of10 percent.

__________

Date of issue

Notes Receivable: an Overview

Interest rate

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Promissory Note

$10,000.00 Nov. 30, 20x4

For value received, I promise to pay to the order of

POPULAR BANK

HOUSTON, TEXAS

TEN THOUSAND AND NO/100DOLLARS

ON FEBRUARY 28, 20x5Plus interest at the annual rate of 10 percent.

__________

Notes Receivable: an Overview

Maturitydate

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Identifying a Notes

Maturity DateWhen the period is given in days

the maturity date is determined by counting

the days from the date of issue.The date the note was issued is omitted.

The maturity date is counted.

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Principal Rate Time = Interest

$10,000 10% 90 360 = $250

Computing Interest on a Note

Compute interest on the note due to Popular Bank.

Principal: $10,000

Interest: 10%

Time: December 1, 20x4, to February 28, 20x5

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Account for notes receivable.

Objective 4

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Recording Notes Receivable

Assume the accounting period ended

December 31.

How much interest was earned by thebank as of December 31?

$10,000 10% (31 360) = $86.11

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Recording Notes Receivable

December 31

Interest Receivable 86.11Interest Revenue 86.11

To accrue interest on the note

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Recording Notes Receivable

How does the bank record the collection

at maturity?

February 28

Cash 10,250.00

Note Receivable 10,000.00

Interest Receivable 86.11

Interest Revenue 163.89Record interest on note

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Dishonored Notes Receivable

If the maker of the note fails to pay the

maturity value to the new payee, then the

original payee legally must pay the bankthe amount due.

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Report receivables

on the balance sheet.

Objective 5

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Reporting Receivables

Some companies report a single amount for

its current receivables in the body of the

balance sheet.They use a note to the financial statements

to give more details.

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Use the acid-test ratio and days

sales in receivables to evaluatea company.

Objective 6

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Acid-test ratio = (Cash + Short-term investments

+ Net current receivables) Total current liabilities

Acid-Test Ratio

This is a stringent test of liquidity.

It measures the entitys ability to pay its

current liabilities immediately.

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Days Sales in Receivables

It is a measure of the time it takes to

collect receivables.

A smaller number indicates a quickconversion to cash.

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One days sales = Net sales 365 days

Days sales in average accounts receivable =

Average net accounts receivable One days sales

Days Sales in Receivables

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