201Lec08.PPTX

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Amounts due from individuals and other companies that are expected to be collected in cash.

Trade Receivables are owed by customers that result from

the sale of goods and services. A/R are not

supported by a formal document.Accounts

ReceivableAccounts

ReceivableNotes

ReceivableNotes

Receivable

“Nontrade” (interest, loans to

employees or officers, income tax

refunds, etc).

Other Receivable

s

Other Receivable

s

ReceivablesReceivables 8

Balance sheet: What amount should be used?

Income statement: When should bad debt expense be recorded?Example: Assume Chuck Co. has:

• $1,000,000 of sales in December 2014, its first year.

• All are on credit, terms net 90 days.

• Gross profit is 40%, operating expenses are $30,000.

Now assume that half of all A/R are uncollectible due to poor credit screening and customer bankruptcies.

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Issues regarding receivables addressed by GAAP:Issues regarding receivables addressed by GAAP:

Allowance Method A/R 1,000,000 - uncollectible - 500,000Net realizable 500,000-------------------------------------

Sales 1,000,000

CGS -600,000

Gross profit 400,000- Operating exp

- 30,000- Bad debt exp

- 500,000Net loss -130,000

Options for 2014 Balance Sheet and Income Statement:

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Direct Method

A/R 1,000,000

-----------------------------------

Sales 1,000,000

CGS -600,000

Gross profit

400,000

- Operating exp -

30,000

Net income

370,000

All receivables should be reported their . . .

Realizable Value

This is the net amount that the company can reasonably expect to collect in cash.

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GAAP Required Balance Sheet Presentation:GAAP Required Balance Sheet Presentation:

Companies don’t know which or when specific receivables will be bad, so . . . .

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they estimate amounts they think are uncollectible.

Use a CONTRA Accounts Receivable account called:

Allowance for Doubtful Accounts

Example: Accounts Receivable reporting

Konk Co. has sales of $5,000,000, of which $700,000

remains uncollected at year end. At year end,

December 31, the credit manager estimates $92,000

will prove uncollectible.

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Konk Co.Balance Sheet (partial)

Current assets Cash $ 14,800

Accounts receivable $700,000Less: Allowance for doubtful accounts - 92,000 608,000

Called “Cash (net) Realizable Value” = expected cash collections

When . . . Review all A/R at same time adjusting entries

are made (at period end)How . . .Many techniques. Age of A/R is most common

method (shown later)Adjusting Journal entry:BAD DEBT EXPENSE xxxx

Allowance for Doubtful Accounts xxxx

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Recording estimates in the Allowance Account:Recording estimates in the Allowance Account:

is an operating expense on the Income Statement.

is an estimate.

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Bad Debt Expense:Bad Debt Expense:

Determining a certain debt is bad won’t be

known until some time in the future (maybe a couple of years!).

- Occurs when a specific customer’s A/R is found out

to be worthless. (bankruptcy, etc.)

- Journal entry is made at this time called a “Write off”

Allowance for Doubtful Accounts xxxx

Accounts Receivable xxxx

Go back to previous Example

Konk Co. has credit sales of $5,000,000, of which $700,000 remains uncollected at year end. The credit manager estimates $92,000 will prove uncollectible.

12/31 Adjusting entry to record allowance and bad debt: Bad Debt Expense 92,000 Allowance for Doubtful Accounts

92,000

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On March 1 of next year, a write-off is needed for $500 owed by I. M. Bad who went bankrupt.Allowance for Doubtful Accounts 500

Accounts Receivable 500

Now assume a write-off is needed:

Accounts ReceivableAllowance for

Doubtful Accounts

Jan 1 Bal 700,000 Mar 1 500

Mar 1 Bal 699,500

Jan 1 Bal 92,000Mar 1 500

Mar 1 Bal 91,500

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Accounts receivable $700,000 $699,500

Allowance for doubtful accts - 92,000 - 91,500

Cash realizable value $608,000 $608,000

Before Write-off After Write-off

Effect of a write off:

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Estimating Bad Debts - Aging ReceivablesEstimating Bad Debts - Aging Receivables

PROCESS of ESTIMATIONFirst breakout A/R into classes based on how old they are. Called an aging schedule.Multiply each class by bad debt %. Older classes have higher %. (less likely they will be paid!)

This result is the desired ending balance in the allowance account.Entry adjusts existing balance to desired balance.

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Accounts Receivable AGING ScheduleAccounts Receivable AGING Schedule

EXAMPLE: A/R: Not Due Yet 10,000 1-30 days past 4,000 31 and older 2,000 16,000Allowance for doubtful accounts 100 credit

ALLOWANCE FOR DOUBTFUL ACCOUNTS100.

1900.

.05 x 10000= 500

.10 x 4000= 400

.50 x 2000=1000 1900

Bad debt expense 1,800 Allowance for doubtful accounts 1,800

????

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Bad debts = 5% of not due, 10% of 1-30 past, 50% over 30.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

100.

1900.

455.230. 60.

75.

355.580.190.

45.

1800.

Estimated side

Actual side

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Allowance not used. (This is a crumby method)

Wait to record bad debt expense when a specific A/R is found to be uncollectible.

BAD DEBT EXPENSE xxxx

A/R xxxx

A/R on balance sheet overstate amounts realistically expected to be received in cash.

Doesn’t match expenses to revenues.

NOT GAAP. Use only if bad debts are negligible.

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Bad Debt Alternative- DIRECT CHARGE OFFBad Debt Alternative- DIRECT CHARGE OFF

Normally requires payment of interest

To the Maker, the promissory note is a note

payable.

To the Payee, the promissory note is a note

receivable.

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Notes ReceivableNotes Receivable

Computing Interest

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Examples:

Notes ReceivableNotes Receivable

On Maturity, maker pays principal + interest

Interest is recorded in period earned Remember “cut off” for

adjusting entries.

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Ye

ar en

d

No

te rec

eive

d

Ma

turity

Interest revenue Interest revenue

Notes ReceivableNotes Receivable

EXAMPLE: On December 1 receive note with Face = $120,000, Life = 90 days, Rate = 10%

December 1

Notes Receivable 120,000.00

Cash, Sales, A/R,etc

120,000.00 Use when you get note. Ignore

interest to be earned. On maturity, receive:

Principal 120,000 + Interest (120,000)(.10)(90/360)

= 120,000 + 3,000.00 = 123,000.00.

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If year end is 12/31, record interest earned with adjusting on

December 31

Interest Receivable 1,000.00

Interest Income 1,000.00

$3,000 interest for 90 days, so 1/3 is earned in 30 days.

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When note collected at maturity on February 28

CASH 123,000.00 N/R 120,000.00 INTEREST INCOME 2,000.00INTEREST RECEIVABLE 1,000.00

If they don’t pay when due (dishonor), write-off to

allowance or record as A/R if collection still possible.

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Receivables often viewed as necessary evils of business

Receivables hinder cash flow and extend the operating cycle.

Cash is better, but competition, marketing, consumer’s buying habits and economic conditions make sales on credit critical to generating revenues!

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Managing ReceivablesManaging Receivables

1. Allow credit card charges

- Retailer pays a % fee to card company

- Non-payment becomes card companies expense

- Bank cards (VISA & MC) are considered same as cash by bank upon deposit.

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Methods used in managing receivablesMethods used in managing receivables

2. Sell receivables to a “factor”

- Fees are charged.

- Customers make payments to factor.

- Payment of receivables is usually guaranteed by selling company.

- Selling notes receivable is called Discounting.

3. Provide terms as incentive for customers to pay

sooner. (Chapter 5, such as 2/10, n/30)

4. Require credit references or perform credit

checks on customers (Dun & Bradstreet, Equifax)

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Methods used in managing receivablesMethods used in managing receivables

5. Monitor collections. Establish policy for overdue

accounts. Helpful ratios include:

a) A/R Turnover = Net Credit Sales

Average A/R

Relates to how fast cash is collected.

b) Average Collection Period (age of receivables)

in days equals: 365 days / receivables

turnover.

Usually, high turnover is good. Means less

money is tied up in receivables, better

cash flow.

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Methods used in managing receivablesMethods used in managing receivables