Define and explain common types of receivables

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1 Chapter 8 Arise from selling goods and services on credit and lending money Right to receive cash in the future from a current transaction Define and explain common types of receivables 3 Amounts to be collected from customers for sales on credit Serves as a control account More formal than accounts receivable Usually longer in term Charge interest to the borrower Promissory note Design internal controls for receivables 5 4

2 Credit department evaluates customers applications Separation of duties Selling on credit Two methods to account for uncollectible accounts Allowance method Direct write-off method 7 8 Based on the matching principle Offset to expense is Allowance for uncollectible accounts Use the allowance method to account for uncollectibles Percent of Sales Income Statement Approach 10 Aging of Accounts Receivable Balance Sheet Approach Uncollectible accounts expense Allowance for uncollectible accounts To estimate bad debts for period 11 12

3 Adjust Allowance for uncollectible accounts to % uncollectible Credit sales Aging Schedule What is uncollectible accounts expense?? Dec 31 Uncollectible account expense Allowance for uncollectible accounts 210 Allowance for uncollectible accounts 210 $1, Days Over 60 days $71,000 $6,000 x 1% x 20% $710 Total $ 210 $77,000 $1,200 $1,910 Allowance for uncollectible accts $1,700 Adjustment needed $210 $1, When a specific customer account is identified as uncollectible, it is written off 16 Sometimes a customer will pay the amount owed after the customer s account is written off Two entries needed Allowance for uncollectible accounts Allowance for uncoll. accounts Cash 17 18

4 Increases (debits) Sales on credit Decreases (credits) Customer payments Write-offs Decreases (debits) Write-offs Increases (credits) Uncollectible account expense entry Recoveries of accounts previously written off Used by small businesses No Allowance for uncollectible accounts Records Uncollectible accounts expense when specific account is written off Understand the direct write-off method for uncollectibles Uncollectible account expense Write off account using direct write off method Overstates Accounts receivable on the balance sheet Violates matching principle Report receivables on the balance sheet 23 22

5 Current asset Shown net of Allowance for uncollectible accounts Two presentation styles: Balance Sheet (Partial) December 31, 2012 Assets Current assets: Accounts receivable Less: Allowance for uncollectible accounts Accounts receivable, net Journalize credit-card, bank card, and debit-card sales $$$$$ ($$$$) $$$$$ Balance Sheet (Partial) December 31, 2012 Assets Current assets: Accounts receivable, net of allowance for doubtful accounts of $$$ $$$$$ 25 Credit card companies (American Express and Discover) pay the retailer and bill the customer Retailers receive cash at time of sale VISA and MasterCard most common bank cards Cash Credit card discount expense Bank card discount expense Sales revenue Accounts receivable Discover Sales revenue 27 Different than credit and bank cards Same as cash Account for notes receivable 29 28

6 Interest starts More formal than Accounts receivable Debtor signs promissory note PROMISSORY PROMISSORYNOTE NOTE Oct. 4, 2010 $10, Amount Date Amount Date For value Principal For valuereceived, received,i Ipromise promiseto topay payto tothe theorder orderof offirst FirstNational NationalBank Bank Ten thousand and no/ dollars Dollars Payee January 2, 2011 on on plus plusinterest interestat atthe theannual annualrate rateof of12%. 12%. Maturity Date Maker Interest Jeanette Sims Rate A 90-day note issued March 13 Maturity date can be: A specific date such as March 13 Stated in terms of number of months Stated in terms of number of days Days in note 90 Days in March 31 Date of issue -13 Days outstanding in March -18 Days remaining 30 Days in May 31 Due date in June Days in April 34 If any notes receivable are outstanding at the end of the period, interest must be accrued Interest is earned over time Revenue must be recorded in the period earned 36

7 Note term = 9 months 4 months 5 months Date of Note, Aug 1, Jan 3 End of Fiscal Year, Dec 31, 2011 Maturity Date, May 1, 2012 Oct 1 Dec 2012 Oct 1 Cash Interest receivable Interest revenue Notes receivable 26, ,800 24, ,920 2, ,000 24,000 24,000 Interest receivable Interest revenue (24,000 x 10% x 3/12) Cash Bank card discount expense Sales revenue Notes receivable Cash If the maker does not pay the note on the due date, the note is dishonored The note is expired, but the maker still owes the company for the maturity value An entry is made to convert the note into an account receivable Notes receivable-name Interest revenue Also called the quick ratio Measures entity s ability to pay its current liabilities immediately Use the acid-test ratio and days sales in receivables to evaluate a company 42

8 Also called collection period Indicates the number of days it takes to collect the average balance of receivables One day s sales = Net sales 365 days Days sales in average accounts receivable = Average net accounts receivable One day s sales 43 44

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