Receivables
• Setting credit policies
• Accounting for bad debt
• Computing interest
Setting credit policies
• Why sell on credit ???
– Increase sales ???
– To remain competitive
Setting credit policies
• Should I sell on credit to you?
– Credit department
• Approve credit sales
– Small businesses
• Generally prefer credit cards
– In effect, company’s credit department
– Credit scoring for individuals
• If denied credit, can get free copy of credit report
– Want stability
– Don’t apply for a lot of cards at the same time
• Credit reports can impact job, rental, life insurance
Bad Debts and Valuing A/R
• Bad debts: an expense of selling on credit
– It should be matched with sales period that
generate bad debts (matching principle)
– If no bad debts…
Methods of recording bad debt
expense
• Direct charge-off: record expense at the
time you find you won’t be paid
– Entry
• Bad Debts Expense
•
A/R
– Acceptable for income tax purposes
– Not acceptable for GAAP as violates matching
principle
Allowance Method
• Bad debt expense is matched against
sales in period the sales were recorded
– Losses must be estimated since companies
don’t know in the period of sale which
account will go bad
• Should take into account prior experience and
current economic conditions
• Must be realistic
• Subject to manipulation ???
ADA
• On balance sheet
– Caterpillar
– A/R
– - ADA
5,611
- 376
Allowance Methods
•
•
•
•
Percent of sales method
Net sales x % bad debt
For example, $1 million x 5%
Then make this entry
– Bad debts expense
–
ADA
$50,000
$50,000
• Focus: income statement, not balance sheet
• Not concerned about ADA balance
Allowance Methods
• A/R aging method
• A/R is aged
– Further past due, likelihood of bad debts grows rapidly
•
•
•
•
• For example, 4% of < 30 days; 40% over 90 days
Multiply A/R x % bad debt for each time period
Calculate total balance needed in ADA
Assume need $50,000 and $20,000 already in ADA
Then make this entry
– Bad debts expense
–
ADA
$30,000
$30,000
• Focus: balance sheet, not income statement
• Not concerned about Bad Debts expense
Entry for write-off of A/R
• Already recorded expense when estimated bad
debts expense under one of allowance methods
– Entry:
• ADA
•
A/R
– Reduces ADA and A/R
– Net A/R remains the same
– If underestimate bad debts, ADA will have a debit
balance
Credit Cards
• VISA and MasterCard
– Credit card slips are similar to depositing
checks into company bank account
– Discount may range from 2-4%
– Entry
• Cash
• Credit card expense
•
Sales
98
2
100
Credit Cards
• Factoring
– Sale of receivables
– With recourse?
– Cost of funds?
Credit Cards
• Store credit card
– No discount fees
– Entry
• A/R
•
100
Sales
100
Gift Cards
• Store gift cards
– Stores love these
– Entry
• Cash
•
?????
– On expiration date
100
100
Notes Receivable
• Promissory note versus A/R
• A/R
– No interest
– Unsecured creditor
• N/R
– Interest
– Secured creditor
Calculating Interest
• Principal x Rate x Time
• Principal = amount loaned
• Make sure time and rate are expressed in
same units
• Interest on $1,000 for 30 days at 10%
– 360 day versus 365 day method