Chapter 8 Reporting and Analyzing Receivables Study Objective 1 - Identify the Different Types of Receivables ♦ The term receivables refers to amounts due from individuals and companies. ♦ Receivables are frequently classified as: 1. Accounts receivable 2. Notes receivable • Represent claims for which formal instruments of credit are issued as evidence of debt. • ____________________________________________________ • Often called trade receivable. • Notes receivable give holder a stronger legal claim to assets than accounts receivable. • Promissory note is a negotiable instrument and may be transferred to another party by endorsement. 3. Other receivables • Nontrade including interest receivable, loans to company officers, advances to employees, and income taxes refundable. Study Objective 2 - Explain how Accounts Receivable are Recognized in the Accounts ♦ Merchandisers record accounts receivable at point of sale of merchandise on account. ♦ Entry is recorded to increase both Sales and Accounts Receivable. ♦ Receivable may be reduced by sales discount and/or sales return. Study Objective 3 – Valuing Accounts Receivable ♦ Credit losses are debited to Bad Debt Expense (or Uncollectible Accounts Expense). ♦ Two methods are used in accounting for uncollectible accounts — the Direct Write-off Method and the Allowance Method. ♦ Direct write-off method Accounts are written off when determined uncollectible by increasing Bad Debt Expense and decreasing Accounts Receivable as follows: Dec. 12 Bad Debts Expense Accounts Receivable—M. E. Doran 200 200 No attempt is made to match bad debts expense to sales revenues in the income statement or to show accounts receivable in the balance sheet at the amount actually expected to be received. Unless bad debt losses are insignificant, the direct write-off method is _____ acceptable for financial reporting purposes. ♦ The allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of each period. Provides better matching on the income statement and ensures that receivables are stated at their__________________________. Cash (net) realizable value is the net amount expected to be received in cash; ______________________________________________________ Receivables are therefore reduced by estimated uncollectible receivables on the balance sheet through use of the allowance method. ♦ Allowance method—required for financial reporting purposes when bad debts are material in amount. 1. Recording estimated uncollectibles 2. Recording the write-off of an uncollectible account 3. Recovery of an uncollectible account 4. Estimating the allowance Study Objective 4 - Compute the Maturity Date of and Interest on Notes Receivable The life of a note may be expressed in months or days. ♦ The formula for computing interest is: Face (principle) x Rate (interest) x Time Study Objective 5 - Describe the Entries to Record the Disposition of Notes Receivable ♦ At the time a note is received, it is recorded at _____________________with no interest added. ♦ Notes receivable are reported at their cash (net) realizable value. ♦ A note is honored when it is paid in full at maturity. ♦ Interest revenue is recorded when the note is paid. However, if interim financial statements are prepared, interest on notes receivable is accrued and shown as interest revenue as it is earned. ♦ If a note is not paid in full at maturity, it is called a dishonored note. Study Objective 6 - Explain the Statement 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. Study Objective 7 - Describe the Principles of Sound Accounts Receivable Management ♦ Determine to whom to extend credit. Risky customers might be required to provide letters of credit or bank grantees Risky customers might be required to pay cash on delivery (COD). ♦ Establish a payment period. Determine a required payment period and communicate that policy to customers. Make sure company's payment period is consistent with that of competitors. ♦ Monitor collections. Prepare accounts receivable aging schedule at least monthly. Pursue problem accounts with phone calls, letters, and legal action if necessary. Study Objective 8 - Identify Ratios to Analyze a Company's Receivables ♦ Liquidity is measured by how quickly certain asset can be converted into cash. The ratio used to assess the liquidity of the receivables is the receivables turnover ratio. ♦ The ratio measures the number of times, on average, receivables are collected during the period. ♦ The collection period should not greatly exceed the credit term period. Study Objective 9 - Describe Methods to Accelerate the Receipt of Cash from Receivables There are three reasons for the sale of receivables. ♦ The first is their size. In recent years, sellers (retailers, wholesalers, and manufacturers) often have provided financing to purchasers of their goods. ♦ Second, receivables may be sold because they may be the only reasonable source of cash. ♦ A final reason for selling receivables is that billing and collection are often time-consuming and costly. Credit Card ♦ A common type of credit card is a national credit card such as Visa, Master Card, and American Express. ♦ Three parties are involved when national credit cards are used in making retail sales: the credit card issuer, who is independent of the retailer, the retailer, and the customer. ♦ A retailer's acceptance of a national credit card is another form of selling— factoring—the receivable. ♦ Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer. These cards are issued by banks.