Accounting Principles Second Canadian Edition Weygandt · Kieso · Kimmel · Trenholm Prepared by: Carole Bowman, Sheridan College CHAPTER 9 ACCOUNTING FOR RECEIVABLES RECEIVABLES • The term receivables refers to amounts due from individuals and other companies; they are claims expected to be collected in cash. • Three major classes of receivables are: 1. Accounts Receivable 2. Notes Receivable 3. Other Receivables ACCOUNTS RECEIVABLE The three primary accounting problems associated with accounts receivable are: 1. Recognizing accounts receivable. 2. Valuing accounts receivable. 3. Disposing of accounts receivable. RECOGNIZING ACCOUNTS RECEIVABLE GENERAL JOURNAL Date July 1 Account Titles and Explanation Accounts Receivable - Adorable Junior Sales To record sales on account. Debit Credit 1,000 When a business sells merchandise to a customer on credit, Accounts Receivable is debited and Sales is credited. 1,000 RECOGNIZING ACCOUNTS RECEIVABLE GENERAL JOURNAL Date July 5 Account Titles and Explanation Sales Returns and Allowances Accounts Receivable - Adorable To record merchandise returned. Debit Credit 100 100 When a business receives returned merchandise previously sold to a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited. RECOGNIZING ACCOUNTS RECEIVABLE GENERAL JOURNAL Date July 31 Account Titles and Explanation Cash ($1,000 - $100) Accounts Receivable - Adorable To record collection of account. Debit Credit 900 900 When a business collects cash from a customer for merchandise previously sold on credit, Cash is debited and Accounts Receivable is credited. RECOGNIZING ACCOUNTS RECEIVABLE GENERAL JOURNAL Date July 31 Account Titles and Explanation Accounts Receivable - Adorable Interest Revenue To record interest on amount due. Debit Credit 13.50 13.50 When financing charges are added to a balance owing, Accounts Receivable is debited and Interest Revenue is credited. VALUING ACCOUNTS RECEIVABLE • To ensure that receivables are not overstated on the balance sheet, they are stated at their net realizable value. • Net realizable value is the net amount expected to be received in cash and excludes amounts that the company estimates it will not be able to collect. VALUING ACCOUNTS RECEIVABLE • Two methods of accounting for uncollectible accounts are: 1. Allowance method 2. Direct write-off method DIRECT WRITE-OFF METHOD • Under the direct write-off method, no entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to Bad Debts Expense. • No attempt is made to match bad debts to sales revenues or to show the net realizable value of accounts receivable on the balance sheet. DIRECT WRITE-OFF METHOD GENERAL JOURNAL Date Jan. 12 Account Titles and Explanation Debit Bad Debts Expense 200 Accounts Receivable — E. Schaefer For write-off of E. Schaefer account. Credit 200 Periera Company writes off E. Schaefer’s $200 balance as uncollectible on January 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles. THE ALLOWANCE METHOD • The allowance method is required when bad debts are deemed to be material in amount. • Uncollectible accounts are estimated and the expense for the uncollectible accounts is matched against sales in the same accounting period in which the sales occurred. THE ALLOWANCE METHOD GENERAL JOURNAL Date Account Title and Explanation Dec. 31 Bad Debts Expense Allowance for Doubtful Accounts To record estimate of uncollectible accounts. Debit Credit 24,000 24,000 Estimated uncollectible amounts are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts (a contra asset account) at the end of each period. ADORABLE JUNIOR GARMET Balance Sheet (partial) Current assets Cash Accounts receivable Less: Allowance for doubtful accounts $ 14,800 $200,000 24,000 Net Realizable Value 188,000 THE ALLOWANCE METHOD GENERAL JOURNAL Date Mar. 1 Account Titles and Explanation Allowance for Doubtful Accounts Accounts Receivable — Nadeau Write-off of Nadeau account. Debit Credit 500 500 Actual uncollectible accounts are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off. THE ALLOWANCE METHOD GENERAL JOURNAL Date July 1 Account Titles and Explanation Accounts Receivable — Nadeau Allowance for Doubtful Accounts To reverse write-off of Nadeau account. Debit Credit 500 500 When there is recovery of an account that has been written off: 1. reverse the entry made to write off the account and ... THE ALLOWANCE METHOD GENERAL JOURNAL Date July 1 Account Titles and Explanation Cash Accounts Receivable —Nadeau To record collection from Nadeau. Debit Credit 500 2. Record the collection in the usual manner. 500 BASES USED FOR THE ALLOWANCE METHOD • Companies use either of two methods in the estimation of uncollectible accounts: 1. Percentage of sales 2. Percentage of receivables • Both bases are GAAP; the choice is a management decision. ILLUSTRATION 9-4 COMPARISON OF BASES OF ESTIMATING UNCOLLECTIBLES Percentage of Sales Matching Sales Percentage of Receivables Net Realizable Value Bad Debts Expense Emphasis on Income Statement Relationships Accounts Receivable Allowance for Doubtful Accounts Emphasis on Balance Sheet Relationships PERCENTAGE OF SALES BASIS • In the percentage of sales basis, management establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. • Expected bad debt losses are determined by applying the percentage to the sales base of the current period. • This basis better matches expenses with revenues. PERCENTAGE OF RECEIVABLES BASIS • Under the percentage of receivables basis, management establishes a percentage relationship between the amount of accounts receivable and the required balance in the allowance account. • This percentage can be applied to the total accounts receivable balance, or to individual accounts receivable balances stratified by age. PERCENTAGE OF RECEIVABLES BASIS • The required balance in the allowance account is determined by applying the percentage to the accounts receivable balance at the end of the current period. • The amount of the adjusting entry to record expected bad debt losses for the current period is the difference between the required balance and the existing balance in the allowance account. • This basis produces the better estimate of net realizable value of receivables. DISPOSING OF ACCOUNTS RECEIVABLE To accelerate the receipt of cash from receivables, owners frequently: 1. sell to a factor, such as a finance company or a bank, and 2. make credit card sales. DISPOSING OF ACCOUNTS RECEIVABLE • A factor buys receivables from businesses for a fee and collects the payments directly from customers. • Credit cards are frequently used by retailers who wish to avoid the paperwork of issuing credit. • Retailers can receive cash more quickly from the credit card issuer. CREDIT CARD SALES • Three parties are involved when credit cards are used in making retail sales: 1. the credit card issuer, 2. the retailer, and 3. the customer. • The retailer pays the credit card issuer a percentage fee of the invoice price for its services. • From an accounting standpoint, sales from bank cards (e.g., Visa and MasterCard) are treated differently than sales from non-bank cars (e.g., American Express). BANK CARD SALES • Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer. • These cards are issued by banks. • Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller’s bank balance. BANK CARD SALES GENERAL JOURNAL Date July 31 Account Titles and Explanation Cash Credit Card Expense ($1,000 x 3.5%) Sales To record VISA credit card sales. Anita Ferreri purchases a number of compact discs for her restaurant from Karen Kerr Music Co. for $1,000 using her Royal Bank VISA card. The service fee that the Royal charges is 3.5 percent. Debit Credit 965 35 1,000 NON-BANK CARD SALES • Sales using American Express and other non-bank cards are reported as credit sales, not cash sales. • Conversion into cash does not occur until American Express remits the net amount to the seller. NON-BANK CARD SALES GENERAL JOURNAL Date July 31 Account Titles and Explanation Accounts Receivable Credit Card Expense ($500 x 5%) Sales To record American Express credit card sales. Kerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent. Debit Credit 475 25 500 NOTES RECEIVABLE • A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. • The party making the promise is the maker. • The party to whom payment is made is called the payee. ILLUSTRATION 9-8 FORMULA FOR CALCULATING INTEREST The basic formula for calculating interest on an interest-bearing note is: Face Value of Note X Annual Interest Rate X Time in Terms of One Year = The interest rate specified on the note is an annual rate of interest. Interest RECOGNIZING NOTES RECEIVABLE GENERAL JOURNAL Date Account Titles and Explanation May 1 Notes Receivable Accounts Receivable — Brent Company To record acceptance of Brent Company note. Debit Credit 1,000 1,000 Wilma Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company to settle an open account. VALUING NOTES RECEIVABLE • Like accounts receivable, short-term notes receivable are reported at their net realizable value. • The notes receivable allowance account is Allowance for Doubtful Notes. HONOUR OF NOTES RECEIVABLE GENERAL JOURNAL Date Account Title and Explanation Sept. 30 Cash Notes Receivable - Higly Interest Revenue To record collection of Higly note. Debit Credit 10,150 10,000 150 • A note is honoured when it is paid in full at its maturity date. • Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5% interest-bearing note, due in 4 months, on September 30. • Wolder collects the maturity value of the note from Higley on September 30. DISHONOUR OF NOTES RECEIVABLE GENERAL JOURNAL Date Account Title and Explanation Sept. 30 Accounts Receivable - Higly Notes Receivable - Higly Interest Revenue To record the dishonour of Higly note. Debit Credit 10,150 10,000 150 • A dishonoured note is a note that is not paid in full at maturity. • A dishonoured note receivable is no longer negotiable. • Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable. BALANCE SHEET 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. • In the balance sheet, short-term receivables are reported within the current assets section below cash and temporary investments. • Both the gross amount of receivables and the allowance for doubtful accounts should be reported. USING THE INFORMATION IN THE FINANCIAL STATEMENTS • Financial ratios are calculated to evaluate the short-term liquidity of a company. • These ratios include the 1. current ratio, 2. acid test (quick) ratio, 3. receivables turnover ratio, and the 4. collection period ratio. CURRENT RATIO • The current ratio (working capital ratio) is a widely used measure for evaluating a company’s liquidity and short-term debt-paying ability. CURRENT ASSETS CURRENT RATIO = —— ————————— CURRENT LIABILITIES ACID TEST RATIO • The acid test ratio (quick ratio) is a measure of a company’s short-term liquidity. CASH + TEMPORARY INVESTMENTS + RECEIVABLES (NET) ACID TEST RATIO = ———————————————————————————— CURRENT LIABILITIES ACCOUNTS RECEIVABLE TURNOVER RATIO • The ratio used to assess the liquidity of the receivables is the receivables turnover ratio. Net Credit Sales Average Net Receivables = Receivables Turnover COLLECTION PERIOD • The collection period in days is a variant of the receivables turnover ratio and makes liquidity even more evident. • The general rule is that the collection period should not exceed the credit term period. Days in Year (365) Receivables Turnover Collection = Period in Days COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. 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