Chapter 7 AC - Financial Accounting: Information for Decisions PDF

Preview

Summary

Chapter 7 Notes...

Description

Chapter 7 Accounting for Receivables I. Accounts Receivable A receivable is an amount due from another party. Accounts Receivable are amounts due from customers for credit sales. A. Sales on Credit 1. Credit sales are recorded by increasing (debiting) Accounts Receivable. a. The General Ledger continues to keep a single Accounts Receivable account. b. A supplementary record (subsidiary ledger), called the accounts receivable ledger, is created to maintain a separate account for each customer. c. The sum of the individual accounts in the accounts receivable ledger equals the debit balance of the Accounts Receivable account in the general ledger. 2. Entry to record credit sale: debit Accounts Receivable—Customer Name, credit Sales. The debit is posted to the Accounts Receivable account in the general ledger and to the customer account in the accounts receivable ledger. 3. Many larger retailers maintain their own credit cards to grant credit to preapproved customers and to earn interest on unpaid balances. The entries are the same as in 2 above except for the possibility of added interest revenue; entry to record accrued interest: debit Interest Receivable, credit Interest Revenue B. Credit Card Sales (examples: Visa, MasterCard, and American Express) 1. Sellers allow customers to use third-party credit and debit cards for several reasons: a. The seller does not have to make decisions about who gets credit and how much. b. The seller avoids the risk of extending credit to customers who do not pay. c. The seller typically receives cash from the credit card company sooner than had it granted credit directly to customers. d. A variety of credit options for customers offers a potential increase in sales volume. e. Credit card companies charge seller a fee between 1-5%. Reported on Income Statement as a selling expense.

C. Valuing Accounts Receivable 1

Accounts of customers who do not pay what they promised are uncollectible accounts, commonly called bad debts. Two methods are used to account for uncollectible accounts. 1. Direct Write-off Method- violates expense recognition principle  No entry until account is known to be uncollectible.  Fails matching test.  Overstates receivables on balance sheet.  Debit allowance and Credit accounts receivable  If recovered, the written off entry is reversed and then a journal entry records the full payment: o Debit account receivable and credit allowance o Debit cash and credit accounts receivable

2. Allowance Method When allowance method is used, bad debts are estimated at the end of the accounting period, and are recorded with the following entry: Debit Bad debt expense Credit Allowance for doubtful accounts Bad Debts Expense is reported under “Selling expenses” in the operating expense section of the income statement. The Allowance for Doubtful Accounts is a contra-asset account reported on the balance sheet. That way we can report the full amount of accounts receivable, and the amount we estimate we won’t collect (the allowance), and the amount we estimate we will collect (the realizable value, which equals Accounts Receivable minus the 2

Allowance for Doubtful Accounts). Both the gross amount of receivables and the allowance for doubtful accounts should be reported. Note that the Realizable Value is added to the other assets to get total assets. See Exhibit 7.6, page 327. Why use the allowance account? We know some receivables will not be collected, but we don’t know who will not pay. Can’t reduce accounts receivable because control account must equal A/R subsidiary ledger, and we won’t write off a customer’s balance until we know it is uncollectible.  Bad debts are estimated at end of year, and Accounts Receivable are reported at realizable value on Balance Sheet. Does not affect net income.  GAAP requires use of the allowance method if bad debts amount is significant. A. Two approaches may be used with the allowance method: 1. Percent of Sales  Best method for matching test.  Income Statement approach. The amount calculated for the journal entry is what we want the bad debt expense to be.  Unadjusted balance for allowance is not considered for the adjusting entry, only for the balance sheet entry 2. Percent of Accounts Receivable (and Aging of Receivables).  Best method for valuing receivables on the balance sheet.  Called the balance sheet approach. The amount calculated is what we want the Allowance for Doubtful Accounts balance to be.  Multiply accounts receivable from past percentage for estimate, Debit Bad debt expense and Credit Allowance for doubtful accounts to achieve the estimate  Add unadjusted debit allowance or less credit allowance  Aging of receivables- classify by how long past due

When an account receivable is known to be uncollectible, the receivable is written off: 3

Debit Allowance for doubtful accounts Credit Accounts receivable NOTE: This will reduce the Allowance and the Accounts Receivable balances by the same amount, so the Realizable Value amount is unchanged (it represents the amount we still estimate we will collect). -

Aging of Receivables Method: uses both past and current receivables information to estimate the allowance amount, classified by how long it is past due

When an account that was written off actually pays: - Debit Account receivable and credit allowance - Debit cash and credit account receivable

4

II.

Notes Receivable Promissory note- written promise to pay, usually with interest, either on demand or at stated future date A.

Calculations for Notes: 1. Calculate the maturity date (due date).  

If term is in days, do not count the date of the note as a day, but do count the maturity date as a day. If term is in months, maturity date is payable in the month of its maturity on the same day of the month as its original date.

2. Calculate the interest. Interest = Principal X Interest Rate X Time.    

Use 360 days (Banker’s Rule). Time is days of note term ÷ 360 or months of note term ÷ 12 So a note due in 60 days at 6% for $2k would be calculated as 2000 x .06 x 60/360 Note that the interest rate is always given as the annual rate. Interest Revenue is shown under “Other Revenues and Gains” in the nonoperating section of the income statement.

3. Calculate the Maturity Value. Maturity Value = Principal + Interest B.

Year-end adjustment is required for accrued interest receivable (revenue recognition principle).

C.

If note is dishonored, maturity value is recorded as an account receivable, and interest revenue earned is recorded. Debit account receivable, credit notes receivable and interest revenue. 5

III.

Disposing of Receivables Reasons for this include the need for cash or a desire to not be involved in collection activities. A. Selling Accounts Receivable A company can sell all or a portion of its receivables to a finance company or a bank to get money faster 1. Buyer, called a factor, charges the seller a factoring fee and then takes ownership of the receivables and receives cash as they become due. 2. Entry (by seller of receivables): debit Cash, debit Factoring Fee Expense, and credit Account Receivable for the receivable amount B. Pledging Receivables A company can pledge its receivables as security for a loan. 1. Borrower retains ownership of the receivables, no risk of bad debts 2. If borrower defaults on the loan, the lender has the right to be paid from the cash receipts of collections on accounts receivable. 3. The borrower’s financial statements must disclose the pledging of the receivables. Buyer is called a factor Credit cash and debit notes payable

IV.

Statement Presentation of Receivables Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. a.

Short-term receivables are reported in the current asset section of the balance sheet below short-term investments. These assets are nearer to cash and are thus more liquid.

b. Notes receivable are listed before accounts receivable because notes are more easily converted to cash. c. If a company has significant risk of uncollectible accounts or other problems with receivables, it is required to discuss this possibility in the notes to the financial statements.

6...