26/04/2015. Chapter 9. Receivables

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Chapter 9 Receivables PowerPoint to accompany: Learning objectives Define and explain common types of receivables and review internal controls for receivables Describe how bad debts arise Use the

1 Chapter 9 Receivables PowerPoint to accompany: Learning objectives Define and explain common types of receivables and review internal controls for receivables Describe how bad debts arise Use the allowance method to account for bad debts Use the direct write-off method to account for bad debts Journalise credit card and debit card sales Account for bills receivable Report receivables on the balance sheet and evaluate a business using the acid-test ratio, days sales in receivables and the accounts receivable turnover ratio Receivables: An introduction A receivable arises when a business (or person) sells goods or services to a second business (or person) on credit The receivable is the seller s claim against the buyer for the amount of the transaction The creditor sells goods or a service and obtains a receivable The debtor makes the purchase and takes on an obligation/payable (a liability) The two main types of receivables are accounts receivable and bills receivable /Horngren, Best, Fraser, Willett/Accounting/7e 1

2 Receivables: An introduction Accounts receivable, sometimes called trade receivables or trade debtors, are amounts to be collected from customers from sales made on credit Bills (and notes) receivable are more formal than accounts receivable. The debtor in a bill or note receivable arrangement promises in writing that the creditor will be paid a definite sum at a specific future date A promissory note is a special type of bill receivable Accounting for bad debts (uncollectable accounts) Some customers do not pay, and that creates an expense called a bad debt expense, doubtful debt expense or uncollectable account expense There are two methods of accounting for uncollectable receivables, namely the allowance method and the direct writeoff method It is based on the matching principle, which requires that the bad debts expense is recorded in the same period as the sales revenue The offset to the expense is a contra account called Allowance for doubtful debts (or the Allowance for bad debts) The Allowance account shows the amount of the receivables that the business expects not to collect and reduces Accounts receivable /Horngren, Best, Fraser, Willett/Accounting/7e 2

The more accurate the estimate of bad debts, the more reliable the information in the financial statements Businesses use their past experience as well as considering the economy, the industry they

3 The more accurate the estimate of bad debts, the more reliable the information in the financial statements Businesses use their past experience as well as considering the economy, the industry they operate in and other variables There are two basic ways to estimate bad debts, namely percentage of sales method and ageing of accounts receivable method The percentage of sales method calculates bad debts expense as a percentage of net credit sales This method is also called the income statement approach because it focuses on the amount of expense to be reported on the income statement Bad debts expense is recorded as an adjusting entry at the end of the period Mar 31 Bad debts expense (E+) 300 GST clearing (L ) 30 Allowance for doubtful debts (CA+) 330 Recorded bad debts expense for the period. The ageing of accounts method is also called the balance sheet approach because it focuses on the actual age of the accounts receivable and determines a target allowance balance from that age /Horngren, Best, Fraser, Willett/Accounting/7e 3

When a specific customer account is identified as uncollectible, it is written off to the allowance account Jul 15 Allowance for doubtful debts (CA ) 200 Accounts receivable Andrews (A ) 80 Accounts

4 When a specific customer account is identified as uncollectible, it is written off to the allowance account Jul 15 Allowance for doubtful debts (CA ) 200 Accounts receivable Andrews (A ) 80 Accounts receivable Jones (A ) 120 Wrote off doubtful debts. Sometimes a customer will pay the amount owed after the customer s account is written off. To account for this recovery, the business must reverse the effect of the earlier write-off to the Allowance account and record the cash collection. Sep 4 Accounts receivable Andrews (A+) 80 Allowance for doubtful debts (CA+) 80 Cash (A+) 80 Accounts receivable Andrews (A ) /Horngren, Best, Fraser, Willett/Accounting/7e 4

5 The direct write-off method Under the direct write-off method of accounting for bad debts, the business waits until it decides that a customer s account receivable is uncollectable The accountant then debits Bad debts expense and credits the customer s Account receivable to write off the account Jul 15 Bad debts expense (E+) 200 Accounts receivable Andrews (A ) 80 Accounts receivable Jones (A ) 120 Wrote off a bad debt. The direct write-off method To account for this recovery, the business must reverse the effect of the earlier write-off to the Bad debts expense account and record the cash collection Sep 4 Accounts receivable Andrews (A+) 80 Bad debts expense (E ) 80 Cash (A+) 80 Accounts receivable Andrews (A ) 80 Credit and debit card sales Credit card sales are an alternative form of receiving payment from a customer There are two main types of credit cards, namely credit cards that are issued by a financial institution (bank or credit union) and credit cards that are issued by a credit card company Credit cards offer customers the convenience of buying without having to pay the cash immediately Debit cards are fundamentally different from credit cards Businesses hire a third-party processor to process credit and debit card transactions Transactions are usually entered into an electronic terminal (card scanner) that the business either purchases or rents from the processor /Horngren, Best, Fraser, Willett/Accounting/7e 5

Bills receivable Bills of exchange are commonly used where foreign trade is concerned, with businesses selling goods or services in exchange for bills receivable A promissory note is defined as an

6 Bills receivable Bills of exchange are commonly used where foreign trade is concerned, with businesses selling goods or services in exchange for bills receivable A promissory note is defined as an unconditional promise in writing, signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money, to or to the order of a specified person, or to bearer A bill of exchange is defined as as an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a sum certain in money to or to the order of a specified person or bearer Bills receivable Identifying a bill s maturity date Maturity date can be a specific date Maturity date can be stated in terms of number of months Maturity date can be stated in terms of number of days The formula for calculating interest is Principal Interest rate Time Amount of interest /Horngren, Best, Fraser, Willett/Accounting/7e 6

7 Recording bills receivable Oct 20 Bill receivable - Dorman Builders (A+) Sales revenue (R+) To record sale. Jan 18 Cash (A+) Bill receivable Dorman Builders (A ) Interest revenue 370 ($ /365) (R+) To record collection at maturity. Recording bills receivable A business may, by agreement, draw a bill receivable on a trade customer who fails to pay an account receivable within the customary days Oct 1 Bill receivable Interlogic (A+) 2400 Accounts receivable Interlogic (A ) 2400 To draw a bill on account on a customer. Accruing interest revenue Dec 31 Interest receivable 54 ($ /12) (A+) Interest revenue (R+) 54 To accrue interest revenue earned in 2015 but not yet received. Sep 30 Cash [$ ($ )] (A+) 2616 Bill receivable Interlogic (A ) 2400 Interest receivable (A ) 54 Interest revenue (R+) 162 To collect bill receivable on which interest has been previously accrued /Horngren, Best, Fraser, Willett/Accounting/7e 7

Discounting a bill receivable Dishonoured bills receivable If the debtor of a bill doesn t pay a bill receivable at maturity, the debtor is said to dishonour, or default on, the bill As the term of

8 Discounting a bill receivable Dishonoured bills receivable If the debtor of a bill doesn t pay a bill receivable at maturity, the debtor is said to dishonour, or default on, the bill As the term of the bill has expired, the original agreement is no longer in force, and no one will buy the bill However, the payee still has a claim against the debtor and usually transfers the claim from the Bills receivable account to Accounts receivable The payee records interest revenue earned on the bill and debits Accounts receivable for the full maturity value of the bill Using accounting information for decision making In making decisions, owners and managers use some ratios based on the relative liquidity of assets A measure of the firm s ability to pay current liabilities is the acid-test (or quick) ratio The acid-test ratio tells whether the entity could pay all its current liabilities if they came due immediately Acid-test ratio = (Cash + Short-term investments+ Net current receivables) / Total current liabilities The higher the acid-test ratio, the better the business is able to pay its current liabilities /Horngren, Best, Fraser, Willett/Accounting/7e 8

9 Using accounting information for decision making After a business makes a credit sale, the next critical event in the business cycle is collection of the receivable Days sales in receivables, also called the collection period, indicates how many days it takes to collect the average level of receivables The number of days in average accounts receivable should be close to the number of days customers are allowed to pay The shorter the collection period, the more quickly the organisation can use cash for operations Using accounting information for decision making The accounts receivable turnover ratio measures the number of times the business sells and collects the average receivables balance in a year The higher the ratio, the faster the cash collections Accounts receivable turnover ratio = Net credit sales / Average net accounts receivable Summary: Chapter 9 A receivable arises when a business (or person) sells goods or services to a second business (or person) on credit The two main types of receivables are accounts receivable and bills receivable There are two methods of accounting for uncollectable receivables, namely the allowance method and the direct writeoff method is based on the matching principle, which requires that the bad debts expense is recorded in the same period as the sales revenue Under the direct write-off method of accounting for bad debts, the business waits until it decides that a customer s account receivable is uncollectable /Horngren, Best, Fraser, Willett/Accounting/7e 9

10 Summary: Chapter 9 Bills of exchange are commonly used where foreign trade is concerned, with businesses selling goods or services in exchange for bills receivable In making decisions, owners and managers use some ratios based on the relative liquidity of assets Common ratios are acid-test (or quick) ratio, collection period, and accounts receivable turnover ratio /Horngren, Best, Fraser, Willett/Accounting/7e 10

Notes Receivable A note is a written promise to pay a specific amount at a specific future date. Includes an interest cost for the term of the note

Notes Receivable A note is a written promise to pay a specific amount at a specific future date. Includes an interest cost for the term of the note RECEIVABLES Accounts Receivable Amounts due from customers for credit sales. Credit sales require: o Maintaining a separate account receivable for each customer. o Accounting for bad debts that result