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Chapter Seven . Accounting for Receivables. Learning Objective 1. Explain the importance of offering credit terms to customers. Offering Credit Terms to Customers. Accounts Receivable. Notes Receivable.
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Chapter Seven Accounting forReceivables
Learning Objective 1 • Explain the importance of offering credit terms to customers.
Offering Credit Terms to Customers Accounts Receivable Notes Receivable Company allows customer to buy on credit. Used when credit term must be longer or receivable is large. Formal credit agreement is written spelling out maturity date, interest rate, and other credit terms Company allows customer to buy on credit. Cash usually collected within 30 days
Uncollectible Accounts Some customers may be unwilling or unable to pay their accounts receivable. Because we do not want to overstate assets, we must show accounts receivable at its net realizable value on the balance sheet. The net realizable value is the face value of the receivables less an estimated allowance for doubtful accounts. Let’s look at the revenue and doubtful account process.
Learning Objective 2 • Explain how the allowance method of accounting for uncollectible accounts affects financial statements.
Revenue Recognition Event 1 Revenue Recognition During 2006, Allen’s Tutoring Services recognized $14,000 of service revenue earned on account.
Collection for Receivables Event 2 Collection of Receivables Allen’s Tutoring Services collected $12,500 cash from accounts receivable in 2006.
Recognizing Uncollectible Accounts Expense Event 3 Recognizing Uncollectible Accounts Expense Allen’s Tutoring Services recognized uncollectible accounts expense for accounts expected to be uncollectible in the future.
General Ledger Accounts Cash Retained Earnings (2) 12,500 Bal. 12,500 Accounts Receivable Service Revenue (1) 14,000 12,500 (2) 14,000 (1) Bal. 1,500 Uncollectible Accounts Expense Allowance for Doubtful Accounts 75 (3) (3) 75 75 Bal. Assets Liabilities Equity = +
Subsequent Period Event 1 Write-Off of an Uncollectible Account Receivable Allen’s Tutoring Services wrote off $70 of uncollectible accounts receivable.
Revenue Recognition Event 2 Revenue Recognition Allen’s Tutoring Services provided $10,000 of tutoring services on account during 2007.
Collection of Accounts Receivable Event 3 Collection of Accounts Receivable Allen’s Tutoring Services collected $8,430 cash from accounts receivable.
Recovery of an Uncollectible Account Event 4 Recovery of an Uncollectible account: Reinstate Receivable Allen’s Tutoring Services recovered a receivable that it had previously written off.
Recovery of an Uncollectible Account Event 5 Recovery of an Uncollectible Account: Collection of Receivable Allen’s Tutoring Services recorded collection of the reinstated receivable.
Year-End Adjusting Entries Event 6 Adjustment for Recognition of Uncollectible Accounts Expense Using the percent of revenue method, Allen’s Tutoring Services recognized uncollectible accounts expense for 2007.
General Ledger T-Accounts Retained Earnings Service Revenue 13,925 Bal. 10,000 (2) Uncollectible Accounts Expense (6) 135 Assets Liabilities Equity = + Cash Bal. 12,500 (3) 8,430 (5) 10 Bal. 20,940 Accounts Receivable 70 (1) Bal. 1,500 (2) 10,000 8,430 (3) (4) 10 10 (5) Bal. 3,000 Allowance for Doubtful Accounts (1) 70 75 Bal. 10 (4) 135 (6) 150 Bal.
Percent of Receivables Method • Alternative to percent of revenue method • Focuses on estimating the most accurate amount for the balance sheet account, Allowance for Doubtful Accounts • The longer an account receivable is outstanding, the less likely to be collected • Aging of accounts classifies all receivables
Balance Required in Allowance Account Ending balance in the Allowance for Doubtful Accounts account should be $3,760.
Learning Objective 3 • Show how the direct write-off method of accounting for uncollectible accounts affects financial statements.
Direct Write-Off Method Event 1 Recognition of Revenue on Account During 2006 Allen’s Tutoring Service recognized $14,000 of revenue on account.
Direct Write-Off Method Event 2 Recognition of Bad Debt During 2008, Allen's Tutoring Services determines that a customer who owes us $70 is unable to pay the amount due.
Direct Write-off Method Event 3: Recovery of $10 account receivable previously written off. First, reverse earlier write-off. Then record $10 payment of accounts receivable.
Learning Objective 4 • Explain how accounting for notes receivable and accrued interest affects financial statements.
Characteristics of Notes Receivable • Legally documented with a promissory note • Maker -- borrower; responsible for paying note on due date • Payee -- loans money to maker; expects payment of principal and interest • Principal -- amount of money loaned
Characteristics of Notes Receivable • Interest -- economic benefit earned by the payee for loaning the principal to the maker • Maturity Date -- date on which maker must repay principal and interest • Collateral -- assets belonging to maker assigned as security to ensure payment of note
Accounting for Notes Receivable Event 1 Loan of money During 2008, Allen's Tutoring Services decides to invest some idle cash. On November 1, 2008, the company loans $15,000 to Stanford Cummings. The note is due in one year and bears interest at an annual rate of 6%.
Accrual of Interest Revenue Event 2 Recognition of Interest Revenue At the end of 2009, Allen's Tutoring Services must accrue interest on its note receivable. $15,000 × 6% × 2/12 = $150 interest revenue
Collecting principal & interest at maturity date Event 3 Collection of principal and interest on the maturity date, October 31, 2009. $15,000 × 6% × 10/12 = $750 interest revenue Now, record payment of principal and interest receivable.
Notes Receivable & Financial Statements Accrual accounting calls for recognizing revenue in the period earned regardless of when cash is collected Remember cash received from interest is shown as an operating activity on the Statement of Cash Flows, but interest revenue is often reported as a non-operating item on the Income Statement.
Learning Objective 5 • Explain how accounting for credit card sales affects financial statements.
Credit Card Sales Rather than maintaining a credit granting department, many companies find it cost beneficial to accept credit cards. The credit card company deducts a fee, usually between 2% and 8%, from the gross amount of the sales, and pays the merchant the net balance (gross sales less credit card fee).
Credit Card Sales Event 1 Recording a Credit Card Sale Allen's Tutoring Services accepts a credit card in payment for services of $1,000. The credit card company charges a fee of 5% of the gross sale.
Credit Card Sales Event 2 Collection of a Credit Card Receivable Allen's Tutoring Services collects the full amount due from thecredit card company.
Learning Objective 6 • Explain the effects of the cost of financing credit sales.
Accounts Receivable Turnover Accounts ReceivableTurnover Ratio SalesAccounts Receivable = The longer it takes to collect accounts receivable, the greater the opportunity cost of lost income.
Days to Collect Receivable Average Number of Days to Collect Accounts Receivable 365Accounts Receivable Turnover Ratio = This ratio often helps simplify the issues surrounding the collections of accounts receivable.
Operating Cycle The operating cycle is the average time it takes a business to convert inventory to accounts receivable plus the time it takes to convert accounts receivable back into cash.