Financial Accounting:
Tools for Business Decision Making, 3rd Ed.
Kimmel, Weygandt, Kieso
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Chapter 8
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Chapter 8
Reporting and Analyzing
Receivables
After studying Chapter 8, you should
be able to:
Identify the different types of receivables.
Explain how accounts receivable are recognized in
the accounts.
Describe the methods used to account for bad
debts.
Compute the interest on notes receivable.
Describe the entries to record the disposition of
notes receivable.
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Chapter 8
Reporting and Analyzing
Receivables
After studying Chapter 8, you should
be able to:
Explain the statement presentation of
receivables.
Describe the principles of sound accounts
receivable management.
Identify ratios to analyze a company's
receivables.
Describe methods to accelerate the receipt of
cash from receivables.
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Receivables...
Amounts due from individuals and
companies - expected to be collected
in cash.
Frequently classified as:
Accounts receivable
Notes receivable
Other receivables
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Receivables Differ Depending On...
Industry
Time of year
Whether the company extends longterm financing
Credit policies
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Accounts Receivable...
Amounts owed by customers on
account.
Result from the sale of goods/services.
Expected to be collected within 30-60
days.
Most significant type of claim held by
company.
Often called trade receivables.
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Problems with Accounts Receivable
Recognizing accounts receivable.
Valuing accounts receivable.
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Accounts Receivables...
Are reduced as a result of:
•Sales discounts
•Sales returns and allowances
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Notes Receivable...
Represent claims for which formal
instruments of credit are issued as
evidence of debt.
2004
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Other Receivables
Nontrade including:
interest receivable
loans to company officers
advances to employees
income taxes refundable
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Accounts Receivable...
Are recorded when service is provided
or at point of sale of merchandise on
account.
Accounts Receivable 100
Sales
100
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Bad Debts Expense...
Is an expense to record estimated
uncollectible receivables.
Keeps expenses from being understated
on the income statement and accounts
receivables from being overstated on the
balance sheet.
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2 Methods for Accounting for
Uncollectible Accounts
The Direct Writeoff Method
The Allowance
Method
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Direct Write-off Method
Bad debt losses are not estimated.
No allowance account is used.
Accounts are written off when
determined uncollectible as follows:
Bad Debts Expense
200
Accounts Receivable--M. E. Doran
200
Bad debt expense will show only actual losses.
Accounts receivable will be reported at gross
amount.
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Direct Write-off Method Issue
No attempt is made to match bad debts
expense to sales revenue.
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Allowance Method
Uncollectible accounts receivable are
estimated and matched against sales in
the same accounting period in which the
sales occurred.
Uncollectible accounts receivable may be
estimated using:
Percentage of sales
Aging of accounts receivable
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Recording Estimated
Uncollectibles
Hampton Furniture has credit sales of
$1,200,000, of which $200,000 remains
uncollected. The credit manager estimates
$12,000 will prove uncollectible.
Bad Debts Expense
12,000
Allowance for Doubtful
Accounts
12,000
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Recording Estimated
Uncollectibles
Bad Debts Expense
12,000
Allowance for Doubtful
Accounts
12,000
Accounts Receivable
Jan 1 Bal 200,000
Allowance for
Doubtful Accounts
Jan 1 Bal 12,000
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Cash (Net) Realizable Value...
Is the net amount expected to be
collected in cash.
Excludes amounts the company
estimates it will not collect.
Keeps receivables from being overstated
on the balance sheet.
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HAMPTON FURNITURE
Balance Sheet (partial)
Current assets
Cash
$ 14,800
Accounts receivable
$200,000
Less: Allowance for doubtful accounts 12,000 188,000
Cash (net) Realizable Value
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HAMPTON FURNITURE
Balance Sheet (partial)
Current assets
Cash
$ 14,800
Accounts receivable
$200,000
Less: Allowance for doubtful accounts
12,000 188,000
Merchandise Inventory
310,000
Prepaid Expense
25,000
Total current assets
$537,800
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Write-off of an
Uncollectible Account
The vice president of finance authorizes a
write-off of $500 owed by R.A. Ware.
Allowance for Doubtful
Accounts
Accounts Receivable-Ware
500
500
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Write-off of an
Uncollectible Account
Allowance for Doubtful
Accounts
500
Accounts Receivable-Ware
Accounts Receivable
Jan 1 Bal 200,000
Mar 1 Bal 199,500
Mar 1 500
500
Allowance for
Doubtful Accounts
Mar 1 500
Jan 1 Bal 12,000
Mar 1 Bal 11,500
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Before Write-off
Current assets
Cash
$ 14,800
Accounts receivable
$200,000
Less: Allowance for doubtful accounts 12,000 188,000
Cash Realizable Value
After Write-off
Current assets
Cash
$ 14,800
Accounts receivable
$199,500
Less: Allowance for doubtful accounts
11,500 188,000
Cash Realizable Value
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Recovery of an
Uncollectible Account
Accounts Receivable-Ware
Allowance for Doubtful
Accounts
500
Cash
Accounts Receivable
500
500
500
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Percentage of Receivables...
Management establishes a
percentage relationship between the
amount of receivables and the
expected losses from uncollectible
accounts.
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Aging of Accounts Receivable
The analysis of customer balances by
the length of time they have been
unpaid. The longer a
debt is outstanding
the less likely it
is to
be paid.
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Trade Receivables...
Notes and accounts
receivables that
result from sales
transactions.
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Notes Receivable...
Credit which is extended by use of a
formal instrument.
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Notes Receivable...
Credit instrument normally requires:
payment of interest
extends for time periods of 60-90 days or
longer.
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Notes Receivable...
Are often accepted from customers
who need to extend payment of an
account receivable.
Are often required
from high-risk
customers.
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Notes Receivable...
Represent claims for which formal
instruments of credit are issued as
evidence of debt.
2004
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Maker
Is the party in a promissory note who is
making the promise to pay.
Payee
Is the party to whom payment of a
promissory note is to be made.
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Formula for Interest
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Interest rate specified on a
note is an annual rate of
interest.
Prorate for shorter times
periods.
1,000 x .12 x 12 months/12months
1,000 x .12 x 1 month/12months
1,000 x .12 x 3
months/12months
1,000 x .12 x 6
months/12months
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1,000 x .12 x 9
Interest rate specified on a
note is an annual rate of
interest.
Time factor is often divided by
360 days
1,000 x .12 x 360 days/360 days
1,000 x .12 x 27 days/360 days
1,000 x .12 x 46 days/360 days
1,000 x .12 x 162 days/360 days
1,000 x .12 x 265 days/360 days
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Notes Receivable...
are recorded at face
value.
are reported at
cash (net)
realizable value.
are honored when
paid in full at
maturity.
are dishonored
when not paid in
full at maturity.
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Notes Receivable...
Interest revenue is recorded when
the note is paid.
If interim financial statements are
prepared, interest on notes
receivable is accrued.
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Notes Receivable...
Each type of receivables should be
identified in the balance sheet or in the
notes to the financial statements.
Short-term receivables are reported in
the current asset section of the balance
sheet below short-term investments.
The gross amount of receivables and the
allowance for doubtful accounts should
be reported.
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Notes Receivable...
Notes receivable are listed before
accounts receivable because
notes are more easily converted
to cash.
Bad debts expense is reported as
a selling expense in the income
statement.
Interest revenue is shown under
other revenues and gains in the
nonoperating section of the
income statement.
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Managing Receivables
Determine to whom to extend credit.
Establish a payment period.
Monitor collections.
Evaluate receivables
balance.
Accelerate cash
receipts from
receivables when
necessary.
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Extending Credit
Risky customers might be required to
provide letters of credit or bank
guarantees.
Risky customers might be required to pay
cash on delivery (COD).
Ask potential customers for references
from banks and suppliers and check the
references.
Periodically check financial health of
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continuing customers.
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.
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Monitoring Collections
Calculate company’s credit risk
ratio.
Prepare accounts receivable aging
schedule at least monthly.
Pursue problem
accounts with:
phone calls
letters
legal action if
necessary.
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Concentration of Credit Risk
Is there a threat of nonpayment from a single
customer or class of customers that could
adversely affect the financial health of the
company.
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Evaluating the
Receivables Balance
Liquidity is measured by how quickly
certain assets can be converted into cash.
The receivables turnover ratio measures
the number of times, on average,
receivables are
collected during
the period.
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Receivables Turnover Ratio=
Net Credit Sales
Average Net Receivables
Is a measure of the liquidity
of receivables.
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Average Collection Period=
365 days
Receivables Turnover Ratio
Is the average amount of time that
a receivable is outstanding
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Accelerating Cash Receipts
Waiting for the normal
collection process cost
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Accelerating Cash Receipts
A bird in the hand is
worth two in the
bush.
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Companies Sell Receivables
They get more sales if they provide
financing to customers.
General Motors Acceptance Corporation
Ford Motor Credit Corporation
They may be the only
reasonable source of cash.
Billing and collection are
often time-consuming
and costly.
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Factor...
Is a finance company or bank that
buys receivables from businesses for
a fee and then collects
payments
directly
from the
customers.
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Expense Associated with Selling
Receivables
If a company usually sells its receivables,
the service charge expense is recorded as
a selling expense.
However, if receivables are sold
infrequently the fee may be reported
under other expenses and losses in the
income statement.
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Credit Card
A common type of
credit card is a
national credit
card such as:
 Visa
 Master Card
American Express
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Credit Card
Three parties are involved when
national credit cards are used in
making retail sales:
the credit card issuer
the retailer
the customer
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Bank Credit Card
Sales resulting from the use of VISA and
MasterCard are considered cash sales by
the retailer.
Upon receipt of credit card sales slips
from a retailer, the bank immediately
adds the amount to the seller's bank
balance.
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Advantages of Credit
Cards to the Retailer
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Advantages of Credit
Cards to the Retailer
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Advantages of Credit
Cards to the Retailer
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Advantages of Credit
Cards to the Retailer
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