Chapter 9 Notes-Mgmt - Summary Fundamental Accounting Principles PDF

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Chapter 9—Accounting for Receivables Accounts Receivable 

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Intro o

Accounts receivable--amounts due from customers for credit sales  When customers use credit cards issued by 3rd parties  When a company gives credit directly to customers  Maintains a separate A/R for each customer  Accounts for bad debt from credit sales Recognizing Accounts Receivable o Sales on Credit  Recorded by debit AR  A company must maintain a separate account for each customer to track how much that customer purchases, has already paid, and still owes  Provides info for billing customers and business analysis  The general ledger has a single AR (control account) and a supplementary AR subledger  General has the sum total of AR and the subledger has the individual amounts for each purchase  Many companies also have their own credit cards to grant credit to approved customers and earn interest on balance not paid within a specific time period  Allows company to avoid fees from cc companies  if customer owes interest, we Dr Interest Receivable and Cr Interest Revenue o Credit Card Sales  Customers make monthly single payment instead of several payments to different creditors and they can defer their payments  Sellers use 3rd party cc companies bcz:  seller doesn’t have to evaluate credit standings or make decisions about who gets credit and how much  seller avoids risk of extending credit to customers who cannot pay (risk is on cc company)  seller gets cash from cc company sooner than if granted credit to customers directly  variety of cc options could lead to increase in sales volume  Cash Received Immediately on Deposit  Dr Cash and Dr CC Exp (1%-5%)  Cr Sales (Rev)  Cash Received After Deposit  Day of Sale o Dr A/R-cc and Dr cc Exp

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o Cr Sales  Day Cash Received o Dr Cash o CrA/R-cc Installment Sales and Receivables  Installment Accounts (or finance) Receivable--amounts owed from credit sales where payment is required in periodic amounts over a period of time  The customer is charged interest  Classified as current (even if over a year) if the seller offers customers such terms regularly

Valuing Accounts Receivable—Direct Write-Off Method o Bad debts—uncollectible accounts—customers who will not pay what they promised  Uncollectable accounts are expense of selling on credit  Granting credit will increase total sales and net income enough to offset bad debts o Recording and Writing Off Bad Debts  Direct write-off method—records loss from uncollectible receivable when it is determined to be uncollectible  Dr Bad Debt Exp and Cr A/R  Debit changes uncollectible amount to the periods bad debt exp and removes its balance from the AR in the GL and ARsub o Recovering a Bad Debt  An account is written off and is later collected  Process  Reinstate amount in AR  Dr AR and Cr Bad Debt Exp  Record full payment of account  Dr cash and Cr AR o Assessing the Direct Write-Off Method  Bad debts are accounted for when an expense is recognized only when a specific account is determined to be uncollectible. The effect of using this method approximates that of the allowance method  Companies weight 2 accounting concepts when considering this method  Matching principle applied to bad debts  If extending credit to customers helped produce sales, then bad debt exp linked to those sales is matched and reported in the same period  Direct write-off does NOT best match sales and exp bcz bad debt exp isn’t recorded until an account becomes uncollectible (which is normally after the period of that credit sale)  To match bad debt exp with sales requires a company to estimate future uncollectible  Materiality constraint applied to bad debts  An amount can be ignored if its effect on the financial statements is unimportant to users’ business decisions

Used when bad debt exp is very small to other financial statement items, such as sales and net income Valuing Accounts Receivable—Allowance Method o Allowance method—matches the estimated loss of uncollectible receivables against sales they helped produce  Advantages  Records estimate bad debt exp in period related to sales  Reports AR on balance sheet as estimated amount of cash to be collected o Recording Bad Debts Expense  Estimates bad debt exp at the end of each acct period and records it with an adjusting entry  Process  Dr Bad Debt Exp and Cr Allow for Doubtful Accts  Allowance for Doubtful Accounts is a contra to AR used instead of reducing AR directly, bcz at the time of the AJE the company doesn’t know if the customer will not pay  Realizable value—the expected proceeds from converting an asset into cash  The current assets is (AR – allow) o Writing Off a Bad Debt (deciding it is uncollectible)  Dr Allowance and Cr AR  It removes from the AR and removes that amount of bad debt from GL  The write-off does NOT affect the realizable value of AR  Doesn’t affect total assets or net income  The current assets is [(AR-write off) – (allow – write off)]  Same total realizable as before write-off o Recovering a Bad Debt  To help restore credit standing, customer will pay after write-off, so it needs to go back on the books before it can be written off with cash  Process  Dr AR and Cr Allow  To reinstate account previously written off  Dr Cash and Cr Ar  To record full payment Estimating Bad Debts—Percent of Sales Method o Apply the allowance method and estimate uncollectibles based on sales and AR o Common methods:  Based on income statement relation between bad debt exp and sales  Based on balance sheet relation between AR and allowance o Percent of sales method—income stmt method—a given percent of a company’s credit sales for the period is uncollectable  The estimate of bad debts is the number used in the AJE  Based on past experience, 0.x% of credit sales is uncollectible. Multiply the % by the total AR and that number is the bed debt exp and allowance Estimating Bad Debts—Percent of Receivables Method o Uses balance sheet relations of AR and allowance amount to estimate bad debts o The goal of bad debt AJE is to make allowance equal the portion of AR to be uncollected 

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The estimated balance for allowance obtained by:  Computing the percent uncollectible from total receivables  Aging AR o Assumes a given % of AR is uncollectible. The percent is based on past experience and is impacted by current economic conditions  Take the allowance from the previous year, subtract the written-offs from current year, and it gives total unadjusted balance.  The AJE is a plug between unadjusted bal. and new year’s allowance total Estimating Bad Debts—Aging of Receivables Method o Aging of AR method uses past and current receivable to estimate allowance amount  How long it is past the due date (more time is more likely uncollectible)  Process  Use unadjusted bal from previous year and subtract the estimated balance currently = required adjustment  The estimated bal. is the total x % for each time frame  The required adj is the plug which is changed in the books  Dr bad debt exp for plug and Dr Allowance for plug o Estimating Bad Debts—Summary of Methods o

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Bad Debt Estimation

Income Statement Focus

Balance Sheet Focus

Percent of Sales (Emphasis on Matching)

Percent of Receivables (Emphasis on Realizable Value)

Aging of Receivables (Emphasis on Realizable Value)

sales x Rate = Bad Debt Expense

AR x Rate = Allowance for Doubtful Accounts

AR (by age) x Rate (by age) = Allowance for Doubtful ccounts

Notes Receivable 

Intro o o o o

Promissory note—a written promise to pay a specified amount of money (with interest) either upon demand or at a future date Used in transactions (paying for products) and lending/borrowing Sellers prefer notes when credit period is long and when the receivable is a large amount Sections of the note  Principal of a note—specified amount of money

Maker—the signer (person who promises to pay) Payee—who is the note going to Interest—charge for using the money until its due date Computing Maturity and Interest o Maturity Date and Period  Maturity date is the day the note must be repaid  Period—time from note’s issuing date until maturity date o Interest Computation  (principal of note) x (annual interest rate) x (time expressed in faction of year) = interest  We treat a year at 360 days—banker’s rule Recognizing Notes Receivable o Dr Notes Receivable and Cr Sales o When there is a note from an overdue customer in order to give a time extension on overdue AR, the note will often collect part of the past-due balance in cash Valuing and Settling Notes o Recording an Honored Note  Maker of the note honors the note and pays in full  Dr cash and Cr NR and Cr Int. Rev o Recording a Dishonored Note  Dr AR and Cr Int. Rev and Cr NR o Recording End-of-Period Interest Adjustment  At year end, record the interest received until that point  Dr Int. Receivable and Cr Int. Rev  When note is completely collected, record all  Dr Cash and Cr Int. Rev (difference that didn’t already record) Cr Int. Rec. (to remove it) and Cr Note Rec.   

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Disposal of Receivables  

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Companies can convert receivables to cash before they are due (common in textiles, apparel, and furniture) Selling receivables o The buyer (factor) charges seller a factoring fee. Then the buyer takes ownership of receivables and receives cash when they come due o The seller receives cash earlier, passes risk of bad debt and pas factoring fee  Sellers always will receive less cash than amount receivable is due  Dr cash and Dr factoring fee expense and Cr AR Pledging Receivables o A company can raise cash by borrowing and pledging receivables a security for the loan  Risk of bad debt not transferred because company still owns receivables  If borrower defaults on loan, lender collects cash from receivable when collected  Dr cash and Cr NP  In financial statement, disclose the pledge of AR and loan  Ex. AR 40,000 is pledged as security for 35,000 NP...