Chapter 8: Reporting and Analyzing Receivables

Accounts receivable
Amounts customers owe on account.
Accounts receivable turnover
A measure of the liquidity of accounts receivable, computed by dividing net credit sales by average net accounts receivable.
Aging the accounts receivable
A schedule of customer balances classified by the length of time they have been unpaid.
Allowance method
A method of accounting for bad debts that involves ESTIMATING uncollectible accounts at the END of each period.

Provides better matching of expenses with revenues on the income statement

Ensures that receivables are stated at their cash (net) realizable value on the balance sheet

3 features of the Allowance Method for uncollectible accounts
1. Companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded.

2. Companies record estimated uncollectibles as an increase (a debit) to Bad Debt Expense and an increase (a credit) to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts Receivable.

3. Companies debit actual uncollectibles to Allowance for Doubtful Accounts and credit them to Accounts Receivable at the time the specific account is written off as uncollectible.

Average collection period
The average amount of time that a receivable is outstanding, calculated by dividing 365 days by the accounts receivable turnover.
Bad Debt Expense
An expense account to record losses from extending credit.
Cash (net) realizable value
The net amount a company expects to receive in cash from receivables.
Concentration of credit risk
The threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company.
Direct write-off method
A method of accounting for bad debts that involves charging receivable balances to Bad Debt Expense at the time receivables from a particular company are determined to be uncollectible.

under this method, bad debt expense will show only ACTUAL losses for bad debts, there are no estimates

***the direct write-off method is not acceptable for financial reporting purposes

Dishonored (defaulted) note
A note that is not paid in full at maturity.
Factor
A finance company or bank that buys receivables from businesses for a fee and then collects the payments directly from the customers.
Maker
The party in a promissory note who is making the promise to pay.
Notes receivable
Written promise (as evidenced by a formal instrument) for amounts to be received.
Payee
The party to whom payment of a promissory note is to be made.
Percentage-of-receivables basis
A method of estimating the amount of bad debt expense whereby management establishes a percentage relationship between the amount of receivables and the expected losses from uncollectible accounts.
Promissory note
A written promise to pay a specified amount of money on demand or at a definite time.
Receivables
Amounts due from individuals and companies that are expected to be collected in cash.
Trade receivables
Notes and accounts receivable that result from sales transactions.
Types of Receivables
1. Accounts Receivable
2. Notes Receivable
3. Other receivables
Other receivables
include nontrade receivables such as…

Interest receivable Loans to company officers
Advances to employees
Income taxes refundable

These do not generally result from the operations of the business.

To record sales on account
Dr. Accounts Receivable
Cr. Sales Revenue
To record merchandise returned
Dr. Sales Returns and Allowances
Cr. Accounts Receivable
To record collection of accounts receivable
Dr. Cash
Dr. Sales Discounts
Cr. Accounts Receivable
To record interest of the amount due
Dr. Accounts Receivable
Cr. Interest Revenue
What are the accounting methods used to book uncollectible accounts?
Direct write-off method for uncollectible accounts

Allowance method for uncollectible accounts

To record write-off of an account under the direct write-off method
Dr. Bad Debt Expense
Cr. Accounts Receivable
To record estimates of uncollectible accounts under the allowance method
Dr. Bad Debt Expense
Cr. Allowance for Doubtful Accounts
To record the write-off of an account under the allowance method
Dr. Allowance for Doubtful Accounts
Cr. Accounts Receivable
To record the reverse write-off and collection of an account under the allowance method
Dr. Accounts Receivable
Cr. Allowance for Doubtful Accounts

Dr. Cash
Cr. Accounts Receivable

To adjust allowance account to total estimated collectibles???
Dr. Bad Debt Expense
Cr. Allowance for Doubtful accounts

The amount of bad debt expense that should be recorded in the adjusting entry is the difference between the required balance and the existing balance in the allowance account

5 issues in recognizing notes receivable
1. Determining the maturity date.
2. Computing interest.
3. Recognizing notes receivable.
4. Valuing notes receivable.
5. Disposing of notes receivable.
Equation to Compute Interest on an interest-bearing note
(face value of note) x (annual interest rate) x (time in terms of a year, months passed, or days passed) = interest
To record the acceptance of a note
Dr. Notes Receivable
Cr. Accounts Receivable
To record the honor/collection of a note and its interest
Dr. Cash
Cr. Notes Receivable
Cr. Interest Revenue
To accrue interest on a note
Dr. Interest Receivable
Cr. Interest Revenue
To record the collection of a note and interest
Dr. Cash
Cr. Notes Receivable
Cr. Interest Receivable
Dr. Interest Revenue
To record the sale of receivables to a factor
Dr. Cash
Dr. Service Charge Expense
Cr. Accounts Receivable
To record Visa credit card Sales
Dr. Cash
Dr. Service Charge Expense
Cr. Sales Revenue
Identify the different types of receivables.
Receivables are frequently classified as accounts, notes, and other. Accounts receivable are amounts customers owe on account. Notes receivable represent claims that are evidenced by formal instruments of credit. Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable.
Explain how accounts receivable are recognized in the accounts.
Companies record accounts receivable when they perform a service on account or at the point-of-sale of merchandise on account. Sales returns and allowances, and cash discounts reduce the amount received on accounts receivable.
Describe the methods used to account for bad debts.
The two methods of accounting for uncollectible accounts are the allowance method and the direct write-off method. Under the allowance method, companies estimate uncollectible accounts as a percentage of receivables. It emphasizes the cash realizable value of the accounts receivable. An aging schedule is frequently used with this approach.
Compute the interest on notes receivable.
The formula for computing interest is:

(face value of note) x (annual interest rate) x (time in terms of a year, months passed, or days passed) = interest

Describe the entries to record the disposition of notes receivable.
Notes can be held to maturity, at which time the borrower (maker) pays the face value plus accrued interest and the payee removes the note from the accounts. In many cases, however, similar to accounts receivable, the holder of the note speeds up the conversion by selling the receivable to another party. In some situations, the maker of the note dishonors the note (defaults), and the note is written off.
Explain the statement presentation of receivables.
Companies should identify each major type of receivable in the balance sheet or in the notes to the financial statements. Short-term receivables are considered current assets. Companies report the gross amount of receivables and allowance for doubtful accounts. They report bad debt and service charge expenses in the income statement as operating (selling) expenses, and interest revenue as other revenues and gains in the nonoperating section of the statement.
Describe the principles of sound accounts receivable management.
To properly manage receivables, management must (a) determine to whom to extend credit, (b) establish a payment period, (c) monitor collections, (d) evaluate the liquidity of receivables, and (e) accelerate cash receipts from receivables when necessary.
Identify ratios to analyze a company’s receivables.
The accounts receivable turnover and the average collection period both are useful in analyzing management’s effectiveness in managing receivables. The accounts receivable aging schedule also provides useful information.
Describe methods to accelerate the receipt of cash from receivables.
If the company needs additional cash, management can accelerate the collection of cash from receivables by selling (factoring) its receivables or by allowing customers to pay with bank credit cards.
Indicate which type of receivable should be recorded

Advanced $1,000 to a trusted employee.

Other Receivables
Indicate which type of receivable should be recorded

Accepted a $2,000 promissory note from a customer as payment on account.

Notes Receivable
Indicate which type of receivable should be recorded

Determined that a $10,000 income tax refund is due from the IRS.

Other Receivables
Indicate which type of receivable should be recorded

Sold goods to a customer on account for $5,000.

Accounts Receivable
Indicate which type of receivable should be recorded

Recorded $500 accrued interest on a note receivable due next year.

Other Receivables
Indicate which type of receivable should be recorded

Loaned a company officer $4,000.

Other Receivables