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CHAPTER 9: ACCOUNTING FOR RECEIVABLES Types of Receivables: amounts due from individuals + other companies, expected cash Accounts

Receivable: owed by customers on account, from sale of g + s: 30 days (current assets): most significant type of claim Notes Receivable: claim: formal instruments of credit issued as proof of debt, includes interest: 30-90 days+ (current/long term). Trade Receivables: from sales transactions (Notes/Accounts) Other Receivables: nontrade receivables: e.g. accruals (interest receivable), recoverable GST, loans to company officers, advances to employees, recoverable income taxes. Current: accruals (1 year), Long Term/Unusual: Loans + Advances (classified and reported separately in current/noncurrent on BS (due dates)) ACCOUNTS RECEIVABLE Accounting Issues: 1) recognizing, 2) valuing, 3) disposing Recognizing Accounts Receivable Sale: DR A/R, CR SALES Return: DR SALES R + A, CR A/R Collection: DR CASH, CR ACCOUNTS RECEIVABLE If customer takes over 30 days, payment of 18% interest: Interest: DR A/R, CR INTEREST REVENUE, To record interest on amount due. Valuing Accounts Receivable Reporting amounts on B.S. (current asset): uncollectible accounts: customers cannot/will not pay back BAD DEBTS EXPENSE: normal/necessary risks of credit: management: a reasonable number = sound credit policy (too low = too strict) (too high = too lenient). Accounting: 1) 2) Direct Write-Off Method for Uncollectible Accounts DR BAD DEBTS EXPENSE, CR ACCOUNTS RECEIVABLE NAME. To write off NAME account Bad debts expense shows actual losses from uncollectibles. A/R reported as gross amount. No matching: expenses recorded in period other than period of revenues. Does not show A/R in Balance Sheet at the amount actually expected to be received. Not acceptable for financial reporting unless it is insignificant. Allowance Methods for Uncollectible Accounts 1) Estimating uncollectible accounts at the end of each period (better matching, A/R stated at net (cash) realizable value on B.S (cash expected to be received), Estimation expense, matched w/ revenues) 2) DR BAD DEBTS EXPENSE (operating expense, selling expense), CR ALLOWANCE FOR DOUBTFUL ACCOUNTS (contra asset). Adjusting Entry 3) DR ALLOWANCE FOR DOUBTFUL ACCOUNTS, CR ACCOUNTS RECEIVABLE. To write off an account. Allowance for Doubtful Accounts: 1 reasons: (1) dont know which specific accounts are uncollectible + unable to credit in accounts subsidiary ledger, (2) contra helps separate estimates from actual amounts.

Balance Sheet Presentation NAME Balance Sheet (partial) December 31, 2002 Current Assets Cash Accounts Receivable Less: Allowances for Doubtful Accounts Merchandise Inventory Prepaid Expenses Total Current Assets $14,800 $200,000 24,000 176,000 310,000 25,000 $525,800

Write Off Methods of collecting past-due accounts: letters, calls, legal actions. Written off when collection seems impossible. Each write off: approved in writing by management (internal control: person unrelated to Every account write off: debited to allowance account, reduces A/R: ONLY BALANCE SHEET. Cash + receivables

Net realizable value remains the same before + after write off

Recovery After write off: affects ONLY BALANCE SHEET 1) Reversing Entry: DR ACCOUNTS RECEIVABLE, CR ALLOWANCE FOR DOUBTFUL ACCOUNTS, To reverse write off 2) Normal: DR CASH, CR ACCOUNTS RECEIVABLE NAME, To record collection. Bases Used for Allowance Method Choice of method: management decision: emphasis on expenses + revenues vs. NVR of A/R 1) Percentage of Sales Income statement viewpoint: better match of revenues + expenses What % of sales is uncollectible: (past experience and anticipated credit policy) applied to total credit sales + net credit sales: DR BAD DEBTS EXPENSE, CR ALLOWANCE FOR DOUBTFUL ACCOUNTS, To record estimated bad debts for the year. Exp: direct % relationship to sales amount. Adjusting entry: existing balance in Allowance ignored adjusted balance = reasonable approximation of NRV of receivables. Percentage of Receivables Basis % of receivables losses from uncollectible amounts: assigned to total or stratified by aging the accounts receivable: classifies customer balances by length of time (improves reliability). % applied to each age category from past experience (2% 75%) Total estimated bad debts = required balance in allowance account. Amount in bad debt adjusting entry = required balance existing balance. DR BAD DEBTS EXPENSE, CR ALLOWANCE FOR DOUBTFUL ACCOUNTS Allowance account: DR Balance (write offs exceed previous estimates for bad debts) DR balance added to required balance Better approximation of NRV. (not better matching) if over 1 year, expenses will not be in the same period.

2) -

Disposing of Accounts Receivable Usual: collect cash + remove. As credit sales + receivables grow: companies frequently sell A/R to another company for cash, shortening cash-to-cash cycle. Why? (1) only reasonable source of cash (cash may be tight, borrow from credit markets costs too high), (2) billing + collection: time consuming + costly. (sell to credit card companies: specialize in billing + collecting) Factored Receivables To a factor: buys receivables from businesses + collects payment from customers. Typically: factor advances 90% of NRV of approved invoices less factors fee (16% - 36%) with recourse (risk) PROS: current financing, accelerate cash receipts, improve financial ratios (receivables turnover) Credit Card Sales 3 parties involved in retail sales: (1) credit card issuer (independent of retailer), (2) retailer, (3) customer Retailer accepted credit card: selling (factoring) receivable. PROS: (1) issuer does credit investigations, (2) maintains customer accounts, (3) undertakes collection process + absorbs losses, (4) receives cash quickly Retailer pays issuer a fee Cash Sales: Bank Credit Cards Sales from credit cards = cash sales by retailer, less service charge (3.5%) DR CASH, DR CREDIT CARD EXPENSE, CR SALES, To record Visa credit card sale. Credit card expense = selling expense in I.S. Credit Sales: Nonbank Credit Cards Nonbank cards: credit sales: converted to cash only when companies remit net amount to seller (1) DR ACCOUNTS RECEIVABLE AMERICAN EXPRESS, DR CREDIT CARD EXPENSE (5%), CR SALES, To record American Express credit card sales. (2) DR CASH, CR ACCOUNTS RECEIVABLE AMERICAN EXPRESS, To record redemption of credit card billing. Debit Card Sales

Spend what is in the bank account (credit cards: allow access to money from bank + financial institutiton: amount charged will be repaid plus interest) At the time: money deducted from account, electronically transferred into retailers bank account, less service fee. Transaction fee: same journal entry as Credit cards, but debit card expense (set fee)

Loans Secured by Receivables Speeding cash flow: going to bank + borrowoing money w/ accounts receivable as collateral. CON: cost: interest on loan, PRO: cash gain. Loan repaid w/ collection of A/R: 75% of A/R (less than 90 days): through opening line of credit NOTES RECEIVABLE Credit granted for promissory note: written promise to pay specified amount of money on demand + by definite date When: (1) lending + borrowing money, (2) amount of transaction + credit period > normal limits, (3) settlement of A/R Maker: party paying. Payee: receives payment (named, or bearer of note). N/ Receivable or N/ Payable Stronger claim on assets than A/R: can be sold to another party (negotiable instruments: eg cheques: transferrable to other parties by endorsement (signature) of payee) Freq. accepted by customers who extend payment of A/R: oft. Required high risk customers Some industries (heavy equip): all credit sales have notes Majority from loans Issues: (1) recognizing, (2) valuing, (3) disposing Calculating Interest: (always) PRINCIPAL VALUE X ANNUAL INTEREST RATE X TIME IN TERMS OF 1 YEAR (only works if you pay interest when you pay the note) = INTEREST Sometimes monthly short term note: interest collected w/ principal when it matures Interest rate specified is annual On demand: interest is calculated for length of time from issue date. Interest is for period in which it is outstanding. Recognizing Notes Receivable DR NOTES RECEIVABLE NAME, CR ACCOUNTS RECEIVABLE NAME, To record acceptance of Brent Company Note. To settle open account. For cash, CR CASH Interest recorded when it is earned as time passes. Valuing Notes Receivable Short term: NRV Allowance for Doubtful Notes Disposing of Notes Receivable May be held until maturity date, with principal plus any unpaid interest due Honouring Notes Paid at full at maturity date. Interest bearing: principal + interest (assuming its due at maturity) DR CASH, CR NOTES RECEIVABLE NAME, CR INTEREST REVENUE, To record collection of Name note. Dishonouring Notes Receivable Not paid at maturity: no longer negotiable, but payee still has claim = transferred to A/R DR A/R NAME, CR N/R NAME, CR INTEREST REVENUE, To record dishonouring of the Name note. Absolutely no chance: written off: DR Allowance for Doubtful Notes. No Int Rev recorded. Any interest previously accrued must be written off. Sale of N/R Sold to 3rd party before maturity date immediate cash. Proceeds (for discounting note) = maturity value less discount fee. Sale widely called discounting NR STATEMENT PRESENTATION OF RECEIVABLES Each major type of receivables: short term receivables current assets (below cash + temporary investment) Record gross amount + allowances A/R also includes current portion of N/R Name

Balance Sheet (partial) January 29, 2000 Current Assets Cash and cash equivalents Accounts Receivable Merchandise Inventories Other current assets $1,774 15,010 81,468 3,223 $101,475

BAD DEBTS EXPENSE, CREDIT CARD EXPENSE, DEBIT CARD EXPENSE selling expenses under operating expenses INT REVENUE: other revenues and gains in non-operating section of IS

Using the Information in the Financial Statements Trade receivables affect cash position: control + evaluation of short-term liquidity need assessment of efficiency of collection (1) Current Ratio (current assets / current liabilities) (2) Acid Test Ratio (quick ratio): companys ability to satisfy its short-term debts immediately; only current assets quickly converted to cash: CASH + TEMPORARY INVESTMENTS + ACCOUNTS RECEIVABLE (net) / CURRENT LIABILITIES = ACID TEST RATIO high: not necessarily a strong liquidity position (artificial high with slow paying customers, without adequate allowance for doubtful accounts) (3) Receivables Turnover: companys efficiency in converting its credit sales into cash. Amount of credit sales or total sales. Whenever a ratio compares a balance sheet figure w/ income statement, B.S. figure must be averaged so they cover the same period of time. NET CREDIT SALES / AVERAGE ACCOUNTS RECEIVABLE = RECEIVABLES TURNOVER Higher the turnover = more liquid (4) Collection Period: converting receivables turnover into number of days it takes the company to collect receivables DAYS IN YEAR / RECEIVABLES TURNOVER = COLLECTION PERIOD Effectiveness of companys credit and collection policies. Collection period should not exceed credit term period (time allowed for payment)