BUS512M. Module 5. Cash and Accounts Receivable

Transcription

1

2 BUS512M Module 5 Cash and Accounts Receivable

3 Current Asset Classification A current asset is defined as any asset that is intended to be converted into cash within one year or the company s operating cycle, whichever is longer. i.e., Cash, Marketable Securities, Accounts Receivable, Inventory, Supplies, Prepaids

4 Proper Cash Management Restrictions placed on a company s access to its cash are typically imposed by creditors to help ensure future interest and principal payments, i.e., loan or debt covenants. Compensating balances are sometimes required Control Record over cash, i.e., bank reconciliation Physical Control over cash, i.e., petty cash, signatures on checks

5 Accounts Receivable Accounts receivable arise from selling goods or services to customers on account. Recorded at face amount to be collected. However, we must also reflect the fact that a portion of A/R may not be collected. Net Realizable Value Reasons for lack of collection: 1. sales discounts (cash discounts) 2. sales returns 3. sales allowances 4. uncollectible A/R (bad debts, doubtful accounts)

6 Cash/Sales Discounts Offered to encourage early payment Examples 2/10, net 30 2/10, EOM Accounting approaches Gross Method - records discounts when taken by customers Net Method - records discounts not taken by customers

7 E6-4 Accounting for cash discounts On May 1, 2012, Crab Cove Fishing Company sold Maine lobster on account for a gross price of $30,000. On May 5, the company sold cod on account for a gross price of $20,000. the terms of both sales were 3/10, n/30. Crab Cove received payment for the first sale on May 6, 2012, and the payment for the second sale on May 31,2012. Provide all necessary journal entries. a. Assume the Gross Method.

8 E6-4 Accounting for cash discounts On May 1, 2012, Crab Cove Fishing Company sold Maine lobster on account for a gross price of $30,000. On May 5, the company sold cod on account for a gross price of $20,000. the terms of both sales were 3/10, n/30. Crab Cove received payment for the first sale on May 6, 2012, and the payment for the second sale on May 31,2012. Provide all necessary journal entries. b. Assume the Net Method.

9 P6-2 Cash Discounts During March the following credit sales and collections occurred. Company prepares quarterly financials. Required: Prepare the journal entries to record these transactions. March 3 Sold goods to AAA for a gross price of $1,400. Terms 2/10,n/30. March 8 Sold goods to BBB for a gross price of $800. Terms 2/10, n/30. March 11 Received full payment from AAA. March 28 Received full payment from BBB. March 29 Sold goods to CCC for a gross price of $1,800. Terms 2/10, n/30.

10 Sales Returns and Allowances Internal control Customer returns and allowances tracked

11 Net Sales in Financial Statements Eli Lilly: NIKE

12 Accounts Receivables in the Financial Statements Income Statement Bad Debts Expense is typically included in Selling Expense, which is often combined with General and Administrative Expense (SG&A) Balance Sheet Accounts Receivable may be shown in any one of the following ways: WALMART:

13 NIKE Balance Sheet and footnote: WALMART footnote: Eli Lilly footnote:

14 Coca Cola Balance Sheet disclosures for 2011 and 2010: Excerpt from Coca Cola s K is a typical footnote disclosure of the activity in the Allowance for Doubtful Accounts:

15 Cash Flow Statement (Indirect Method) may be shown as an adjustment to net income for the change in Accounts Receivable, Net, such as with Eli Lilly below:

16 Or as a separate adjustment for the Provision for Bad Debts and the remaining change in Accounts Receivable:

17 Direct Write- off Method for AR Used primarily in Cash Basis Accounting No adjusting journal entry Write- off entry Recovery entry

18 Accounting for Bad Debts Specific Write-off or Allowance Method? Specific Write-off Method: Recognize Bad Debts Expense when individual accounts are determined to be uncollectible Allowance Method: Estimate Bad Debts Expense each year and reduce Accounts Receivable using a contra account. Move the reduction from the contra to the Accounts Receivable account when a specific account is known to be uncollectible Entry: Bad Debts Exp. Accounts Rec. xx xx % of Sales Method Recognize Bad Debts Expense for the amount of bad debts expected to result from the current year s sales, using a percent of sales Which method is used to estimate bad debts expense? % of Accounts Receivable Method Recognize Bad Debts Expense for the amount that will cause the contra account balance to equal the % of yearend accounts receivable not expected to be collected. Aging of Accounts Receivable Method Same as the % of Accounts Receivable Method except it uses different percentages for accounts based on their age -- higher % for older accounts. Journal Entries for Allowance Method on next slide

19 Journal Entries for Allowance method of Accounting for Bad Debts To record bad debts expense: Bad Debts Expense Allowance for Uncollectible Accounts xxx xxx To write off bad accounts: Allowance for Uncollectible Accounts Accounts Receivable xxx xxx

20 Recovery of Bad Debts If a receivable is collected after it has been written off, it should be restored by making the reverse of the entry that was made to write it off: Allowance Method Accounts Receivable Allowance for Bad Debts Specific Write-Off Method Accounts Receivable Bad Debts Expense xxx xxx xxx xxx The collection of the receivable is then recorded in the usual fashion: Cash Accounts Receivable xxx xxx

21 Allowance for Doubtful Accts. (T- account) Allowance for Doubtful Accts. Write- off of accounts receivable Beginning Balance Accounts Receivable Beginning Bal. Credit sales Recover write off Ending Bal. Recover write-off AJE estimates bad debt expense Ending Balance Customer pays AR Write- off AJE estimates bad debt expense Bad Debts Expense The AJE to record the estimate of uncollectibles. Agingcalculates the expense amount necessary to achieve the desired ending balance in the allowance account. OR % of Sales is the Expense and then compute EB in Allowance account.

22 BE6-1 Analysis of AR: The following information was taken from the 2009 Annual report of Emerson Electric Co. Balance Sheet (in millions): Receivables were in 2009 $3,623 and in 2008 $4,618; less allowance for uncollectibles of $93 and $90, respectively. a. Compute total AR as of the end of 2009 and 2008, and compute the bad debt allowance as a % of total AR. Did the % increase or decrease? b. The bad debt expense reported on Emerson s 2009 income statement did not equal $93. Explain why.

23 Estimating Bad Debt Expenses Percent of Sales Method Percent of Accounts Receivable Method Aging of Accounts Receivable Method Note on estimating bad debts using the allowance method: Regardless of which method is used to estimate bad debts (% of sales, % of accounts receivable, or aging of accounts), in the final analysis the balance in the allowance account on the balance sheet should represent a fair expectation of the amount that will not be collected of the outstanding accounts receivable. Hence, the net accounts receivable balance on the balance sheet should represent the expected net realizable value of the receivables.

24 Bad Debts/Doubtful Accounts/Uncollectible Accounts Note that we do not know in this year which A/Rs will not be collected in future. Therefore, we must estimate uncollectibles. We will focus on the % of Sales or Aging of AR to estimate uncollectibles for the AJE. The percentage of sales method is simpler, but the Aging of A/R method is more accurate. Under IFRS, the methods used to estimate and account for uncollectible are very similar to those under US GAAP.

25 Percentage of Sales Method Usually based on credit sales, but may use total sales or net sales as basis. Calculation: Sales x % = Bad Debt Expense (focus on the debit side of the AJE) Called the Income Statement approach, because: revenues x % = expense. After making entry find the resulting ending balance in the Allowance account.

26 P6-4 Uncollectibles over two periods Company uses the percentage- of- net- sales method to account for bad debts. Historically, 3% of net sales have proven to be uncollectible. During 2014 and 2015: Gross sales $1,500,000 $1,800,000 Sales discounts 100, ,000 Sales returns 50,000 20,000 a. Prepare the necessary adjusting entries on 12/31/14 to record the estimated bad debt expense. b. Assume the 1/1/2014 Allowance account balance was $65,000(credit) and that $70,000 in bad debts were written off during year. What is the 12/31/14 balance after adjustments.

27 P6-4 Uncollectibles over two periods Company uses the percentage- of- net- sales method to account for bad debts. Historically, 3% of net sales have proven to be uncollectible. During 2014 and 2015: Gross sales $1,500,000 $1,800,000 Sales discounts 100, ,000 Sales returns 50,000 20,000 c. Prepare the necessary adjusting entries on 12/31/15 to record the estimated bad debt expense. d. What is the 12/31/2015 Allowance balance? Assume that $85,000 in bad debts was written off during the year.

28 E6-5 Bad debts under the allowance method. Arlington Cycle Company began operations on 1/1/11. The company reported the following on its 2011 financials: Gross sales in 2012 $1,400,000 and $1,500,000 in AR in 2012 $600,000 and $650,000 in Actual bad debt write- offs in 2012 $22,000 and $10,000 in Arlington estimates bad debts at 2% of gross sales. Analyze the activity in the allowance for doubtful accounts T- account, and comment on whether the bad debt estimate has been sufficient to cover the writeoffs.

29 Gross sales in 2012 $1,400,000 and $1,500,000 in AR in 2012 $600,000 and $650,000 in Actual bad debt write- offs in 2012 $22,000 and $10,000 in Arlington estimates bad debts at 2% of gross sales.

30 P6-3 Bad debts over time The company estimates bad debts at 3% of credit sales. The beginning balance in the Allowance for doubtful accounts as of the beginning of 2013 was $10, Credit sales $205,000 $200,000 $180,000 Actual bad debt write- offs 11,000 10,000 6,000 a. Provide the journal entries related to the Allowance account for all three years.

31 P6-3 Bad debts over time The company estimates bad debts at 3% of credit sales. The beginning balance in the Allowance for doubtful accounts as of the beginning of 2013 was $10, Credit sales $205,000 $200,000 $180,000 Actual bad debt write- offs 11,000 10,000 6,000 b. Compute the balance in the allowance account at 12/31/15. c. Comment on the sufficiency of the bad debts expense and the allowance over the 3 years.

32 Aging Method: Percentages of A/R Based on ending A/R and ending Allowance account. Calculation: Ending A/R x % = Ending Allowance (focus on the credit side of the AJE) Called Balance Sheet approach, because: ending asset x % = ending contra asset. Requires the analysis of the Allowance account and A/R before preparing the AJE. An aging schedule of A/R is the most accurate way to estimate uncollectibles (see Figure 6-11).

33 E6-10 Aging schedule preparation Compute the total receivables and expected bad debts as of the end of the year based on the following: Account age Balance Noncollection Probability Current $290,000 2% 1-45 days past due 110,000 5% days past due 68,000 8% Over 90 days past due 40,000 15%

34 Aging of AR Emory Company uses the accounts receivable aging method to estimate uncollectible accounts. At the beginning of the year, the balance of the Accounts Receivable account was a debit of $90,430, and the balance of Allowance for Uncollectible Accounts as a credit of $8,100. During the year, the company had sales on account of $475,000, sales returns and allowances of $6,200, worthless accounts written off of $8,800, and collections from customers of $452,730. At the end of year (December 31, 2015), a junior accountant for Emory Company was preparing an aging analysis of accounts receivable. At the top of page 5 of the report, the following totals appeared: Customer Account Total Not Yet Due 1 30 Days Past Due Days Past Due Days Past Due Balance Forward $89,640 $49,030 $24,110 $9,210 $3,990 $3,300 Over 90 Days Past Due To finish the analysis, the following accounts need to be classified: From past experience, the company has found that the following rates are realistic for estimating uncollectible accounts: Time Percentage Considered Uncollectible Not yet due days past due days past due days past due 25 Over 90 days past due 50

35 Required Complete the aging analysis of accounts receivable. Compute the end- of- year balances (before adjustments) of Accounts Receivable and Allowance for Uncollectible Accounts. Prepare an analysis computing the estimated uncollectible accounts. Calculate Emory Company's estimated uncollectible accounts expense for the year (round the amount to the nearest whole dollar). What role do estimates play in applying the aging analysis? What factors might affect these estimates?

36 Year- end Entries: Bad Debts During 2010, Omega Company had net sales of $11,400,000. Most of the sales were on credit. At the end of 2010, the balance of Accounts Receivable was $1,400,000, and Allowance for Uncollectible Accounts had a debit balance of $48,000. Omega Company's management uses two methods of estimating uncollectible accounts expense: the percentage of net sales method and the accounts receivable aging method. The percentage of uncollectible sales is 1.5 percent of net sales, and based on an aging of accounts receivable, the end- of- year uncollectible accounts total $140, Prepare the end- of- year adjusting entry to record the uncollectible accounts expense under each method. 2. What will the balance of Allowance for Uncollectible Accounts be after each adjustment? 3. Why are the results different? 4. Which method is likely to be more reliable? Why?

37 During 2010, Omega Company had net sales of $11,400,000. Most of the sales were on credit. At the end of 2010, the balance of Accounts Receivable was $1,400,000, and Allowance for Uncollectible Accounts had a debit balance of $48,000. Omega Company's management uses two methods of estimating uncollectible accounts expense: the percentage of net sales method and the accounts receivable aging method. The percentage of uncollectible sales is 1.5 percent of net sales, and based on an aging of accounts receivable, the end- of- year uncollectible accounts total $140, Prepare the end- of- year adjusting entry to record the uncollectible accounts expense under each method. 2. What will the balance of Allowance for Uncollectible Accounts be after each adjustment?

38

39 Write- off of Accounts Receivable Colby Company, which uses the allowance method, has Accounts Receivable of $65,000 and an allowance for uncollectible accounts of $6,400 (credit). The company sold merchandise to Irma Hegermanfor $7,200 and later received $2,400 from Hegerman. The rest of the amount due from Hegermanhad to be written off as uncollectible. Using T accounts, show the beginning balances and the effects of the Hegermantransactions on Accounts Receivable and Allowance for Uncollectible Accounts. What is the amount of net accounts receivable before and after the write- off?

40 E6-8 Write- offs and Entries The company estimates bad debts each year at 2% of credit sales. End of the year amounts from the annual report are: a. Compute the actual amount of write- offs during year Credit sales $75,300 $61,500 Accounts receivable 9,400 9,200 Allowance for bad debts 1,300 1,000 Bad debt recoveries b. Infer the journal entries that explain the accounts receivable and the related allowance accounts activity during the year.

41 P6-7 Ignoring Potential Bad Debts Income Statement Balance Sheet Sales $200,000 Cash $5,000 Cost of goods sold 102,000 Accounts receivable 85,000 Gross profit 98,000 Other assets 40,000 Expenses 65,000 Total assets $130,000 Net income $33,000 Current liabilities 13,000 Long- term NP 80,000 SHE 37,000 Total L + SHE $130,000 The above financial information is for the Hadley Company s first year of operation. The income statement was not adjusted for bad debt expense. A large percentage of sales were to 3 customers, one of which, LitzenbergerSupply is in questionable financial health, although still in business. Litzenbergerowes Hadley $50,000 as of the end of first year.

42 P6-7 continued Required: a. Adjust the financial statements of Hadley Company to reflect a more conservative reporting with respect to bad debts, i.e. set up a provision. Recompute net income. How does this adjustment affect your assessment of Hadley s first year of operations? b. Why would auditors probably require that Hadley choose the more conservative reporting? c. Hadley s CFO claims that no bad debt expense should be recorded because Litzenberger is still conducting operations as of the end of year. How would you respond to this claim?

43 Liquidity Ratios Working Capital =CA- CL Current Ratio = CA/CL Quick Ratio or Acid Test Ratio = (CA- Inv & Prepaids)/CL How are these ratios affected by the journal entries you will learn this chapter? Sale on Account: Cash Collection: AR Writeoff: AR Recovery: Bad Debt AJE:

44 Liquidity Ratios Working Capital =CA- CL Current Ratio = CA/CL Quick Ratio or Acid Test Ratio = (CA- Inv & Prepaids)/CL How are these ratios affected by the journal entries you will learn this chapter? Sale on Account: Cash Collection: AR Writeoff: AR Recovery: Bad Debt AJE:

45