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Learn about the types, recognition, valuation, and disposition of accounts receivable in financial statements. Explore methods for recording cash discounts, accounting for bad debts, and estimating bad debt expenses.
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ACCOUNTING FOR ASSETS ACCOUNTING FOR RECEIVABLES
Learning objectives The objectives of this session are to enable the learner: • Types of accounts receivable • Recognition of accounts receivable in the financial statements • Valuation of accounts receivable • Disposition of receivable
What are Receivables ? • Receivables represent claims from money, goods, services and other noncash assets from other firms. • Often supported by a sales invoice • Notes receivables are supported by formal promissory notes. • Trade receivables describe amounts owed by the company for goods and services sold in the normal course of the business.
Types of AR AR can be classified into 3 types: • Current or non-current • Trade or non-trade • Accounts or notes receivable
Discounts • A trade discount reduces the list sales price to the net sales price charged to the customer. • A cash (sales) discount can only be taken if the customer makes the payment within a specified time period.
Accounts Receivable Recognition: Recording Cash Discounts There are two methods: Gross and Net • Gross method records discounts when taken by customers. • Net method records discounts not taken by customers.
GROSS method NET method Accounts Receivable: Recording Cash Discounts • Record revenue at gross amount of sales. • When customer takes the discount, record cash discounts. • Cash discounts reduce gross sales revenue. • Record revenue at gross amount of sales less cash discount. • When customer forfeits discount, record discounts not taken. • Report discounts forfeited as other revenue.
Example 1 • Assume that N Limited sells goods to S limited at Sh. 1,000,000 on credit. Credit terms are 2/10, n/30. • N’s entries for the selected events will be:
Accounting for bad debts • Bad debts occurwhen customers do not pay for items or services purchased on credit. • Bad debts are uncollectible accounts receivable. • Bad debt expense is reported as a selling or general and administrative expense. • Accounts receivable are reported on the balance sheet at net realizable value; that is, the expected cash value.
Methods of Accounting for bad debts 1. Direct Write off Method. • Involves debiting Bad Debts Expense accounts and crediting accounts receivable in the period in which the firm finally realizes that the accounts are uncollectible. • The Allowance Method • A company estimates the total amount of its uncollectible accounts at the end of every accounting period. • It satisfies the matching principle.
The Allowance method • Increase in allowance is charged to the Statement of P & L as an expense. • Decrease in allowance is credited to the Statement of P & L as income. • In the Statement of financial position the allowance for doubtful debt at the end of the period is deducted from the receivables.
Estimating bad debts • Two methods can be applied to estimate the bad debt expense at the end of the year. • a) Income statement approach • (The Percentage of credit/total sales) • b) Balance Sheet approach • (Percentage of accounts receivable) • Under the balance sheet approach there are 2 methods that can be used. Percentage of accounts receivable and Ageing of accounts receivable
(a) Income Statement Approach • The estimated bad debts is determined by multiplying current period sales by an established bad debt percentage based on past history and current economic trends.
(b) Balance Sheet Approach • The focus is on the collectability of accounts receivable to make an estimate of uncollectible accounts. • The desired allowance for uncollectible accounts using a percentage of accounts receivable is computed.
Balance Sheet Approach • (i) Percentage of accounts receivable • The total accounts receivable for P Limited are Sh 50,000 and it is estimated that 3% of those accounts will be uncollectible, the allowance account already has a Sh 600 credit balance. • Compute the allowance for bad debts for the period.
Balance Sheet Approach • (ii) Aging Receivables • The most commonly used method for establishing an allowance based on outstanding receivables involves aging receivables. • Individual accounts are analyzed to determining those not yet due and those past due.
Presentation of Receivables in the Financial Statements • Current receivables may be grouped in the balance sheet in the following classes: • Notes receivable—trade debtors • Accounts receivable—trade debtors • Other receivables • It is possible to combine trade notes and accounts receivable into a single amount. • Restrictions on any receivables should be disclosed.
Example 2 • You are required to show the debtors balance and how this balance will be shown in the statement of financial position given the following information:
Impairment of receivables • IASB-Companies should assess their receivables for impairment each reporting period and start the impairment assessment by considering whether objective evidence indicates that one or more loss events have occurred.
Examples of loss events • Significant financial problems of the customer. • Payment defaults.
IASB Impairment process • Receivables that are individually significant should be considered for impairment separately. If impaired the Co. recognizes it. • Any receivable individually assessed that is not considered impaired should be in a group with similar credit risk. • Any receivables not individually assessed should be collectively assessed for impairment.
What is a loan note? • A negotiable instrument that a maker signs in favor of a designated payee who may legally and readily sell or transfer the note to others.
Notes Receivable Short term N/R Long term N/R Record at face value less allowance Record at present value of cash expected to be collected Recognition of Notes Receivable
Recognition of Notes Receivable • Notes receivable are issued at face value when the stated rate of interest is the same as the effective (market) rate. • If the stated rate is less than the effective rate then a discount results. • If the stated rate is greater than the effective rate then a premium results. • The discount or premium is amortized to interest revenue by the effective interest method.
Notes issued at face value Illustration: Pablo ltd . Lends Jentayu Ltd goods worth Ksh 1000,000 in exchange for a three year note bearing interest @ 10% p.a. The market rate of interest or a note of similar risk is 10%. Compute the PV or exchange price.
Notes not issued at face value (Zero-interest bearing notes) • Omwami Ltd receives a three year, 1000,000 zero interest bearing note, the PV is 772180.The implicit rate is 9%. Using the effective-interest method armotize the discount.
Interest bearing notes • J.Kloop makes a loan to W.Enger and receives in exchange a three year, 1000,000 note bearing interest at 10% p.a. The market rate of a note of similar risk is 12%. Compute the PV of the two cash flows, then amortize the discount using the effective interest method.
Secured Borrowing Sale With Recourse Without Recourse Continuing involvement by seller No continuing involvement by seller Accounting for Transfers of Receivables Transfers
Disposition of AR • Contractual right to receive the cash flows no longer exist. • Transfer of AR to another party through: • Secured borrowing. • Sale of receivables/ Factoring.
Secured borrowing • Transferor records a finance charge. • Transferor collects accounts receivable. • Transferor records sales returns and sales discounts. • Transferor absorbs bad debts expense. • Transferor records interest expense on notes payable. • Transferor pays on the note periodically from collections.
Sale of Receivables • Transferor transfers ownership of receivables to factor. • Factor records the (transferred) accounts as assets in its books. • Transferor records any amount retained by transferee as “due from factor.” • Transferor records loss on sale of receivables. • Transferor records any component liability (when appropriate).
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