Chapter 5 - Lecture notes 5 PDF

Preview

Summary

Chapter 5 notes....

Description

Chapter 5: Receivables and Sales Aging Method: used to get a more accurate estimate for uncollectable accounts 1. Determine the age to various accounts of receivable 2. Place each account into an age group 3. Determine estimated percent uncollectible for each age group Notes Receivable: are similar to accounts receivable but are more formal credit arrangements evidenced by a written debt instrument or note.  Typically arise from loans to other entities, loans to stockholders and employees, and the occasional sale of merchandise, other assets, or services  Promissory note  Debit notes receivable; credit service revenue  Can charge interest on notes receivable o Interest = Face Value x Annual interest rate x Fraction of the year (6 months is 6/12)  When note it paid o Debit to cash for the amount + interest o Credit notes receivable for the amount and credit interest revenue for interest Estimate Uncollectible Accounts  Percentage of receivables method = balance sheet o Estimates uncollectible accounts based on the percentage of accounts receivable expected not to be collected  Percentage of credit sales method = income statement method  Bad debt expense represents the cost of the estimated future bad debts  Allowance for uncollectible accounts represents the amount of accounts receivable we do not expect to collect  The difference between total accounts receivable and the allowance for uncollectible accounts is referred to as net accounts receivable which is net realized value How to write off accounts receivable as uncollectible: Debit bad debt expense; credit allowance for uncollectible accounts; contra asset for amount When a company cannot pay  Allowance for uncollectible accounts debt  Accounts receivable credit

 No effect on balance sheet or income statement – both are assets If a company (previously written off) comes to pay off their debt  First entry o Debt allowance receivable o Credit allowance for uncollectible accounts o (reestablish portion of account previously written off)  Second entry o Debit cash o Credit accounts receivable credit Allowance for uncollectible accounts sheet Debit Credit Beginning estimate Write-offs Recovery of previously written off accounts Balance before adjustment  if the balance before adjustment is on the credit side… the estimate was too high  if the balance before adjustment is on the debit side… the estimate was too low o The adjustment :  Bad debit expense debit  Allowance for uncollectible accounts credit Recording an allowance for future uncollectible accounts  Net realizable value: amount of cash the firm expects to collect o Upside: Allowing customers to pay with credit boosts sales o Downside: Not all customers will pay their accounts fully  Uncollectible accounts: (bad debts) are customers' accounts that we no longer consider collectible  Allowance method: GAAP requires that we account for uncollectible accounts using this method accounts for bad debts that has not occurred yet, but is likely to occur  To use the allowance method, a company first estimates at the end of the current year how much in uncollectible accounts will occur in the following year CONTRAST the allowance method and direct write off method Allowance Direct write off

- GAAP requires the allowance method for financial reporting purposes

- Used for tax reporting purposes - Only used for financial reporting when uncollectible accounts are NOT anticipated or are immaterial - Uncollectible accounts are NOT estimated - Bad debts are recorded when the account is actually not paid - Assets are overstated and operating expenses are understated in prior year

Receivables Analysis  Amount of accounts receivable is influenced by: o Level of sales o Nature of the product or service o Credit and collection policies  Two important ratios that help in understanding the company's effectiveness o Receivables turnover ratio = net credit sales / average accounts receivable  Shows number of times during a year average accounts receivable is collected o Average collection period = 365 days / receivables turnover  Shows the approximate number of days the average accounts receivable balance is outstanding  Companies want high Receivables turnover ratio and low Average collection period  % Increase in receivables > % increase in sales = RTR goes down and ACP goes up o This could indicate that customers are dissatisfied with the product or that company’s payment terms for attracting new customers are too generous which in turn could increase sales returns and bad debts  Net Revenues = total revenue – discounts – returns – allowances  Trade discount = reduction in the listed price of a product or service o This provides incentives to larger customer groups o A way to change prices without publishing a new price or to disguise real prices from competitors

o They recognize trade discounts indirectly by recording the sale at the discounted price o Sales discount  4/10 discount = 4% if the amount owed is paid within 10 days  n/30 = if the customer does not take the discount, the full payment is due in 30 days o Sales return  Reduce the customer’s account balance if the sale was on account or issue a cash refund o sales allowance = when the product isn’t returned but the customer gets their money back anyways Recognize Accounts Receivable  Credit sale: if you sell a product or service to someone and accept that person’s promise to pay you in the future – also known as sale on account o Benefit is that the seller makes it more convenient for the buyer to purchase goods and services – should increase profitability in long run o Credit sales typically include  Informal credit agreement  Invoice  Require payment in 30-60 days o Accounts receivable = trade receivables  Accounts receivables represent the amount of cash owed to a company by its customers from the sale of products or services on account  Originates from credit sales...