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Classification of Receivables

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Classification of Receivables

Chapter 8

    Receivables

    Classification of Receivables

    Receivables:

    o Includes all money claims against other entities, including

    people, business firms, and other organization.

    o Are usually a significant portion of the total current assets.

    o Types of Receivables:

    o Accounts receivable :

    ; Results from the sale of merchandise on

    credit and expected to be collected within a

    relatively short period, such as 30 or 60 days.

    o Notes receivable:

    ; Are amounts that customer owe, for which a

    formal written instrument of credit has been

    issued.

    ; Are usually used for credit periods of more

    than sixty days.

    ; May be used to settle a customer’s accounts

    receivable

Uncollectible receivables

    o When allowing customers to purchase on credit, we run the risk

    of nonpayment.

    o Many retail businesses may shift the risk of uncollectible to

    other companies. Allow only VISA or Mastercard.

    o Companies may also sell their receivables to other companies.

    Usually companies issue their own credit cards.

    o Regardless of the care used in granting credit and the collection

    procedures used, a part of the credit sales will not be collectible.

    o Bad debts expenses operating expense recorded from

    the uncollectible receivables.

Created by: M. Mari

    Fall 2007

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Chapter 8

    Receivables

    Two methods of accounting for receivables:

    1. Allowance method

     2. Direct write off method

    Remember from Why? Allowance method: Chapter 1 ! Matching ; Required by generally accepted accounting principles principle

    (GAAP)

    ; Estimates the accounts receivable that will not be collected

    and records bad debt expense for this estimate at the end of

    each accounting period.

    ; We create a CONTRA ASSET ACCOUNT called Allowance

    for Bad Debts. It increases with a credit.

    ; Record the total estimate that has not been written off.

    ; Entry is considered an adjusting entry.

    Example 1: Suppose that accounts receivable have a balance of $105,000 and it is estimated that $4,000 will go bad in the next period.

Date Account Pr Debit Credit

    May Uncollectible account 4,000

    21 expense

     Allowance for bad debts 4,000

Net Realizable Value =

     Accounts receivable balance Allowance for bad debts

    What is really expected to be collected!

Created by: M. Mari

    Fall 2007

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Chapter 8

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    Write offs to the Allowance Account

    o Once that we determine that a particular customer will be not

    collectible, we write off the account.

    o The write off consists of reducing the allowance account by the

    amount of the write off and removing the uncollectible account

    from accounts receivable.

    Example 2: Suppose that J Mays account with a balance of $1,200 is uncollectible.

Date Account Pr Debit Credit

    May Allowance account 1,200

    31

     Accounts receivable 1,200

Estimating Uncollectibles

    o The allowance method estimates bad debts expense at the end

    of the period.

    o Estimate of uncollectibles at the end of a fiscal period is based

    on past experience and forecasts of the future.

    o Two methods are used:

    o Estimated based on percentage of sales

    o Analysis of accounts receivable.

     Estimate Based on Sales:

    o We assume that a percentage of credit sales will go

    bad and record that as the adjusting entry.

    Example 3: Suppose that credit sales for the period were $800,000 of which 1% is expected to be uncollectible. Record the entry. Created by: M. Mari

    Fall 2007

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Chapter 8

    Receivables

     $800,000 x 1% = $ 8,000

     Account Pr Debit Credit

May Uncollectible account 8,000

    21 expense

     Allowance account 8,000

    Example 4: Suppose that the company expects 3% of credit sales to go uncollected. A review of the trial balance shows:

     Sales $1,000,000 of which 45% are cash sales.

     Accounts receivable has a balance of $70,000.

     Allowance for bad debts has credit balance of $2,000.

    Credit sales are $1,000,000 x 55% = $550,000 Estimate is $550,000 x 3% = $16,500

    Allowance for Bad Debts

    CREDIT DEBIT

    $2,000 balance

    $16,500 should be balance

As a result of the credit balance in the Allowance account, we will

    record the entry not for $16,500 but $14,500 ( $16,500 - $2,000).

Date Account Pr Debit Credit

    May Uncollectible account 14,500

    21 expense

     Allowance account 14,500

Created by: M. Mari

    Fall 2007

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Chapter 8

    Receivables

    Example 5: Suppose that the company expects 3% of credit sales to go uncollected. A review of the trial balance shows:

     Sales $1,000,000 of which 45% are cash sales.

     Accounts receivable has a balance of $70,000.

     Allowance for bad debts has debit balance of $2,000.

    Credit sales are $1,000,000 x 55% = $550,000 Estimate is $550,000 x 3% = $16,500

    Allowance for Bad Debts

     DEBIT CREDIT

    $2,000 balance

    $16,500 should be balance

As a result of the debit balance in the Allowance account, we will

    record the entry not for $16,500 but $18,500 ( $16,500 + $2,000).

Date Account Pr Debit Credit

    May Uncollectible account 18,500

    21 expense

     Allowance account 18,500

    When the Allowance Account at the end of the year:

     Has a debit balance we underestimated the bad debts last period.

     Has a credit balance we overestimated the bad debts last period.

Estimate Based on Analysis of Receivables

    Created by: M. Mari

    Fall 2007

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Chapter 8

    Receivables

     This is done through an aging of accounts receivables

    Age Interval Balance Percent Amount Not past due $75,000 2% $1,500 1 30 $4,000 5% $200 31 60 $3,100 10% $310 61 90 $1,900 20% $380 91 180 $1,200 30% $360 181 365 $800 50% $400 Over 365 $300 80% $240 Total $86,300 $3,390 The aging is done by multiplying the balance times the percent to get the amount.

    Date Account Pr Debit Credit May Uncollectible account 3,390 21 expense

     Allowance account 3,390

Direct Write off Method

    ; There is no estimated uncollectibles

    ; There is no allowance account

    ; Only when a specific customer goes bad will it be written off

    to the expense account.

    Suppose that Haby’s account goes bad with a balance of

    $8,000.

    Date Account Pr Debit Credit May Uncollectible account 8,000 21 expense

     Accounts receivable 8,000

    Reinstatements of Write offs:

     Allowance method:

    Created by: M. Mari

    Fall 2007

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    Chapter 8

    Receivables

    Date Account Debit Credit

    May 21 Accounts receivable $8,000

     Allowance account $8,000

    For the amount originally written off then record the collection of

    funds.

     Direct Write off Method:

    Date Account Debit Credit

    May 21 Accounts receivable $8,000

     Bad Debts expense $8,000

    For the amount originally written off then record the collection of

    funds.

    Characteristics of Notes Receivable:

    ; Promissory note is a written promise to pay a sum of

    money on demand or at a definite time.

    ; Payee the person to whom the note is payable to

    ; Maker one making the note and owing the money

    ; Due date when the note is due

    ; Maturity value = principal + interest

    Before calculators Computation of Due Date easier to use

    360 days to

    make Created by: M. Mari

    calculations Fall 2007

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    Receivables

    o The length of time that the note is open is usually stated in days

    or months.

    o Use 360 day year for easy of computation in class but in real

    life we use 365 day year.

     stExample: Suppose that a note is issued on May 1 for 60 days when is the note due.

     May 31 days in May

     -1 date the note is issued

    30 days the note exists in May

    60 days in the note

    30 Date in June the note is due.

Computation of Interest due

     Principal X Rate X Time = Interest

     Amount owed Percentage of Amount in dollars spent on

    interest on note interest Days on note charged 360

Example: Suppose that face or principal of note is $30,000, interest

    rate is 10% for 60 days.

    Principal X Rate X Time = Interest

$30,000 X 10% X 60/360 = $500 interest due with note

    Maturity value = Principal + Interest

     = $30,000 + $500

     = $30, 500

Created by: M. Mari

    Fall 2007

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    Example: Suppose that a note for $20,000 with 12% is issued on June 5 for 90 days. Compute the due date, interest, and maturity value of the note.

Accounting for Notes Receivables

    o A customer may use a note to replace an account receivable.

    o This causes the creation of a note receivable and the

    removal of the outstanding accounts receivable.

    Example: Suppose that the account for Mister is past due. Mister converts the receivable to a note for 60 days at 10%. The balance is $6,000.

Date Account Pr Debit Credit

    May 21 Notes receivable $6,000

     Accounts receivable $6,000

     Mister pays amount due on the date.

Date Account Pr Debit Credit

     Cash $6,100

     Notes receivable $6,000

     Interest receivable $100

    When the note is paid on the due date, it said that the note is HONORED.

Dishonored Notes

    o When the maker does not pay the maturity value on the due

    date, the note is said to be DISHONORED

    o At this time, the note ceases to exist, the maturity value of the

    note is reported again as an Accounts Receivable. Created by: M. Mari

    Fall 2007

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    o We include the interest computed as income earned but

    not yet received.

    Example: Suppose that the account for Mister is past due. Mister converts the receivable to a note for 60 days at 10%. The balance is $6,000. On the due date, the note becomes dishonored

Recording dishonored note

    Date Account Pr Debit Credit

     Accounts receivable $6,100

     Notes receivable $6,000

     Interest receivable $100

    Notice that the difference is that we debit accounts receivables instead of cash.

Created by: M. Mari

    Fall 2007

    Page 10 of 10

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