الثلاثاء، 12 أبريل، 2016

Summarization chapter 9- ACCOUNTING FOR RECEIVABLES

Summarization chapter 9-

 ACCOUNTING FOR RECEIVABLES

 Accounts receivable
are amounts customers owe on account. They result from the sale of goods and services. Companies generally expect to collect accounts receivable within 30 to 60 days. They are usually the most
significant type of claim held by a company.
Notes receivable
 are a written promise (as evidenced by a formal instrument) for amounts to be received. The note normally requires the collection of interest and extends for time periods of 60–90 days or longer.
Notes and accounts receivable that result from sales transactions are often called trade receivables.
Other receivables
include nontrade receivables such as interest receivable, loans to company offi cers, advances to employees, and income taxes refundable. These do not generally result from the operations of the business. Therefore, they are generally classified and reported as separate items in the balance sheet.

Accounts Receivable

Recognizing Accounts Receivable
A merchandiser records accounts receivable at the point of sale of merchandise on account. When
a merchandiser sells goods, it increases (debits) Accounts Receivable and increases
(credits) Sales Revenue.
The seller may offer terms that encourage early payment by providing a discount. Sales returns also reduce receivables. The buyer might fi nd some of the goods unacceptable and choose to return the unwanted goods



Valuing Accounts Receivable

Companies report accounts receivable on the balance sheet as an asset. But determining the amount
to report is sometimes difficult because some receivables will become noncollectable
Companies record credit losses as debits to Bad Debt Expense (or Uncollectible Accounts Expense).
Two methods are used in accounting for uncollectible accounts:
(1) the direct 
write-off method and 
(2) the allowance method. The following sections explain these methods.


(1) the direct write-off method and 


Under the direct write-off method, companies often record bad debt expense
in a period different from the period in which they record the revenue. The method
does not attempt to match bad debt expense to sales revenues in the income statement.
Nor does the direct write-off method show accounts receivable in the balance
sheet at the amount the company actually expects to receive. Consequently,
unless bad debt losses are insignificant, the direct write-off method is not
acceptable for financial reporting purposes.

(2) the allowance method.
The allowance method of accounting for bad debts involves estimating noncollectable
accounts at the end of each period

GAAP requires the allowance method for financial reporting purposes when bad debts are material in amount. This method has three essential features
1. Companies estimate uncollectible accounts receivable. They match this estimated
expense against revenues in the same accounting period in which they
record the revenues.
2. Companies debit estimated uncollectibles to Bad Debt Expense and credit
them to Allowance for Doubtful Accounts through an adjusting entry at the
end of each period. Allowance for Doubtful Accounts is a contra account to
Accounts Receivable.
3. When companies write off a specific account, they debit actual uncollectibles to
Allowance for Doubtful Accounts and credit that amount to Accounts Receivable.


RECORDING THE WRITE-OFF OF AN UNCOLLECTIBLE ACCOUNT

Bad Debt Expense does not increase when the write-off occurs. Under the allowance
method, companies debit every bad debt write-off to the allowance
account rather than to Bad Debt Expense. A debit to Bad Debt Expense would be
incorrect because the company has already recognized the expense when it made
the adjusting entry for estimated bad debts. Instead, the entry to record the write-off
of an uncollectible account reduces both Accounts Receivable and Allowance for
Doubtful Accounts.


RECOVERY OF AN UNCOLLECTIBLE ACCOUNT

a company collects from a customer after it has written off the account as uncollectible. The
company makes two entries to record the recovery of a bad debt: 
(1) It reverses the entry made in writing off the account. This reinstates the customer’s account.
(2) It journalizes the collection in the usual manner






ESTIMATING THE ALLOWANCE


companies must estimate that amount when they use the allowance method. Two bases
are used to determine this amount:
 (1) percentage of sales 
 (2) percentage of receivables.
The choice is a management decision.


In the percentage-of-sales basis, management estimates what percentage of credit sales will be uncollectible. This percentage is based on past experience and anticipated credit policy


Percentage-of-Receivables.
Under the percentage-of-receivables basis, management
estimates what percentage of receivables will result in losses from uncollectible
accounts. The company prepares an aging schedule, in which it classifies
customer balances by the length of time they have been unpaid. Because of its
emphasis on time, the analysis is often called aging the accounts receivable

This amount represents the required balance in Allowance for Doubtful
Accounts at the balance sheet date. The amount of the bad debt adjusting
entry is the difference between the required balance and the existing balance
in the allowance account
If the trial balance shows Allowance for Doubtful
Accounts with a credit balance of $528, the company will make an adjusting
entry for $1,700 ($2,228 2 $528), as shown here.



Disposing of Accounts Receivable
In the normal course of events, companies collect accounts receivable in cash
and remove the receivables from the books 
Companies now frequently sell their receivables to another company for cash,
thereby shortening the cash-to-cash operating cycle.
Companies sell receivables for two major reasons. 
First, they may be the only reasonable source of cash.
second reason for selling receivables is that billing and collection are
often time-consuming and costly.

SALE OF RECEIVABLES
A common sale of receivables is a sale to a factor. A factor is a fi nance company
or bank that buys receivables from businesses and then collects the payments
directly from the customers. Factoring is a multibillion dollar business 
the factor charges a commission to the company that is selling the receivables. This fee ranges from 1–3% of the amount of receivables purchased




CREDIT CARD SALES

Over one billion credit cards are in use in the United States—more than three credit
cards for every man, woman, and child in this country. Visa, MasterCard, and American
Express are the national credit cards that most individuals use
Three parties are involved when national credit cards are used in retail sales: 
(1) the credit card issuer,
who is independent of the retailer; 
(2) the retailer
 (3) the customer






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Notes Receivable

Companies may also grant credit in exchange for a formal credit instrument
known as a promissory note. A promissory note is a written promise to pay a
specified amount of money on demand or at a definite time. Promissory notes may
be used (1) when individuals and companies lend or borrow money, (2) when the
amount of the transaction and the credit period exceed normal limits, or (3) in
settlement of accounts receivable.

Computing Interest

the basic formula for computing interest on an interest bearing note.




There are different ways to calculate interest. For example, the computation
in  assumes 360 days for the length of the year. Most financial
instruments use 365 days to compute interest. For homework problems, assume
360 days to simplify computations.

Recognizing Notes Receivable

the basic entry for notes receivable, we will use Calhoun Company’s
$1,000, two-month, 12% promissory note dated May 1. Assuming that Calhoun
Company wrote the note to settle an open account, Wilma Company makes the
following entry for the receipt of the note.


The company records the note receivable at its face value, the amount shown
on the face of the note. No interest revenue is reported when the note is accepted,
because the revenue recognition principle does not recognize revenue until the
performance obligation is satisfied. Interest is earned (accrued) as time passes

Valuing Notes Receivable
Valuing short-term notes receivable is the same as valuing accounts receivable



Disposing of Notes Receivable (sell them)

HONOR OF NOTES RECEIVABLE
A note is honored when its maker pays in full at its maturity date


ACCRUAL OF INTEREST RECEIVABLE

Suppose instead that Wolder Co. prepares financial statements as of September 30

DISHONOR OF NOTES RECEIVABLE
A dishonored (defaulted) note is a note that is not paid in full at maturity



Presentation
Companies should identify in the balance sheet or in the notes to the fi nancial
statements each of the major types of receivables. Short-term receivables appear in
the current assets section of the balance sheet. Short-term investments appear
before short-term receivables because these investments are more liquid (nearer to
cash). Companies report both the gross amount of receivables and the allowance
for doubtful accounts.



Analysis

Investors and corporate managers compute fi nancial ratios to evaluate the liquidity
of a company’s accounts receivable. They use the accounts receivable turnover to
assess the liquidity of the receivables. This ratio measures the number of times, on
average, the company collects accounts receivable during the period. It is computed
by dividing net credit sales (net sales less cash sales) by the average net accounts
receivable during the year. Unless seasonal factors are signifi cant, average net
accounts receivable outstanding can be computed from the beginning and ending
balances of net accounts receivable.


The result indicates an accounts receivable turnover of 7.2 times per year. The
higher the turnover, the more liquid the company’s receivables.
A variant of the accounts receivable turnover that makes the liquidity even more
evident is its conversion into an average collection period in terms of days. This is
done by dividing the accounts receivable turnover into 365 days. For example,
Cisco’s turnover of 7.2 times is divided into 365 days, as shown in Illustration 9-18,
to obtain approximately 51 days. This means that it takes Cisco 51 days to collect its
accounts receivable.


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