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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