Transcript Plillips/Libby/Libby Chapter 8

Chapter 8
Reporting and
Interpreting Receivables,
Bad Debt Expense, and
Interest Revenue
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Accounts Receivable
Accounts
Receivable
Amounts owed by
other companies
or persons for
cash, goods, or
services.
Open accounts
owed to the
business by trade
customers.
8-2
Notes Receivable
A note receivable is a written contract
establishing the terms by which a
company will receive amounts it is owed.
Companies may convert
accounts
receivable balances to
notes for customers
who are having difficulty
paying their receivables.
8-3
Notes Receivable
$1,200
Term
Sixty days
Principal
the order
of
January 5, 2008
Payee
after date I promise to pay to
Skechers U.S.A., Inc.
One thousand two hundred --------------------------------- Dollars
Payable at
Interest
Rate Bank
First
National
Value received with interest at
No. 8563
Due
8%
March 6, 2008
per annum
Alan Jones
Jones Athletic Company
Due Date
8-4
Learning Objective 1
Describe the tradeoffs
of extending credit.
8-5
Pros and Cons of Extending Credit
Businesses extend credit to
generate additional sales and to
meet the terms offered by competitors.
Extending credit is likely to increase
sales, but not without costs:
Bad debts
costs
Increased wage costs
to manage receivables
Delayed receipt
of cash
8-6
Learning Objective 2
Estimate and report
the effects of
uncollectible
accounts.
8-7
Accounts Receivable
and Bad Debts
Bad debts result from credit customers
who will not pay the business the amount
they owe, regardless of collection efforts.
8-8
Accounts Receivable
and Bad Debts
Bad debts are likely to be discovered in
periods after the credit sale.
If bad debts are not reported until discovered,
income is distorted in the periods of sale as
well as in the period of bad debt discovery.
Year 1
(Credit Sale Occurs)
Revenues
$ 10,000
Cost of goods sold
6,000
Bad debt expense
0
Net income
$ 4,000
Year 2
(Bad Debt discovered)
Revenues
0
Cost of goods sold
0
Bad debt expense
1,000
Net income
$ (1,000)
8-9
The Allowance Method of
Accounting for Bad Debts
Bad Debt
Expense
Matching
Principle
Record in same
accounting period.
Sales
Revenue
8-10
The Allowance Method of
Accounting for Bad Debts
Most businesses record an estimate of
the bad debt expense with an adjusting
entry at the end of the accounting period.
8-11
Record Estimated
Bad Debt Expense
For the year ended December 31, 2005,
Skechers U.S.A., Inc., estimated its
bad debt expense to be $2,882,000.
Prepare the adjusting entry.
Accounts
Debit
Credit
8-12
Record Estimated
Bad Debt Expense
For the year ended December 31, 2005,
Skechers U.S.A., Inc., estimated its
bad debt expense to be $2,882,000.
Prepare the adjusting entry.
Bad Debt Expense is normally classified as a
selling expense and is closed at year-end.
Accounts
Bad Debt Expense (+E, -SE)
Allowance for Doubtful Accounts (+xA, -A)
Debit
2,882,000
Credit
2,882,000
Contra asset account
8-13
Allowance for Doubtful Accounts
Balance Sheet Disclosure
Accounts Receivable
Less: Allowance for Doubtful Accounts
Net Accounts Receivable
Amount the business
expects to collect.
8-14
Remove (Write Off) Specific
Customer Balances
When it is clear that a specific customer’s
account receivable will be uncollectible, the
amount should be removed from the
Accounts Receivable account and charged
to the Allowance for Doubtful Accounts.
8-15
Remove (Write Off) Specific
Customer Balances
Skechers’ total write-offs for
2005 were $1,729,000.
Prepare a summary journal
entry for these write-offs.
Accounts
Debit
Credit
8-16
Remove (Write Off) Specific
Customer Balances
Skechers’ total write-offs for
2005 were $1,729,000.
Prepare a summary journal
entry for these write-offs.
Accounts
Allowance for Doubtful Accounts (-xA)
Accounts Receivable (-A)
Debit
1,729,000
Credit
1,729,000
8-17
Remove (Write Off) Specific
Customer Balances
Assume that before the write-off, Skechers’
Accounts Receivable balance was
$56,000,000 and the Allowance for
Doubtful Accounts
balance was $6,043,000.
Let’s see what effect the total write-offs of
$1,729,000 had on these accounts.
8-18
Remove (Write Off) Specific
Customer Balances
Before
Write-Off
Accounts Receivable
$ 56,000,000
Less: Allow. for Doubtful Accts.
6,043,000
Net Accounts Receivable
$ 49,957,000
After
Write-Off
$ 54,271,000
4,314,000
$ 49,957,000
Notice that the total write-offs of $1,729,000 did not
change the net accounts receivable value nor did it
affect any income statement accounts.
8-19
Estimating Bad Debts
Aging of Accounts Receivable
Focus is on determining the desired
balance in the Allowance for Doubtful
Accounts on the balance sheet.
????
8-20
Aging Schedule
Each customer’s account is aged by separating
the total amount owed by each customer into
aging categories based on the number of days
that have passed since uncollected amounts
were first recorded in the account.
Let’s look on the next slide to see an aging of
accounts receivable for Skechers (all amounts
in thousands).
8-21
Aging Schedule
(in thousands)
Number of Days Unpaid
Customer
Adam's Sports
Backyard Shoe
Total A/R
Balance
0-30
30-60
$
648 $
405 $
198
2,345
60-90
$
45
Over 90
$ 2,345
Other Customers
138,803
96,255
18,458
19,605
4,485
Total
$ 141,796 $ 96,660 $ 18,656 $ 19,650 $ 6,830
% Uncollectible
Next, based on past experience, the business
Estimated
Uncoll. Amount
estimates the percentage of uncollectible
accounts in each time category.
8-22
Aging Schedule
(in thousands)
Number of Days Unpaid
Customer
Adam's Sports
Backyard Shoe
Total A/R
Balance
0-30
30-60
$
648 $
405 $
198
2,345
60-90
$
45
Over 90
$ 2,345
Other Customers
138,803
96,255
18,458
19,605
4,485
Total
$ 141,796 $ 96,660 $ 18,656 $ 19,650 $ 6,830
% Uncollectible
1%
4%
14%
40%
Estimated
Uncoll. Amount
Now we will multiply these percentages
by the appropriate column totals.
8-23
Aging Schedule
(in thousands)
Number
Days Unpaid
The column totals are
thenofadded
to
arrive at the total estimate of
Total A/R
uncollectible
accounts
of $7,196.
Customer
Balance
0-30
30-60
60-90
Over 90
Adam's Sports
Backyard Shoe
$
648 $
2,345
405 $
198
$
45
$ 2,345
Other Customers
138,803
96,255
18,458
19,605
4,485
Total
$ 141,796 $ 96,660 $ 18,656 $ 19,650 $ 6,830
% Uncollectible
1%
4%
14%
40%
Estimated
Uncoll. Amount
$ 7,196 $
967 $
746 $ 2,751 $ 2,732
8-24
Aging of Accounts Receivable
(in thousands)
of Days
Unpaid
Record the year-endNumber
adjusting
entry
assuming that the Allowance for
Total A/R
Doubtful
Accounts
has
Customer
Balance
0-30 currently
30-60
60-90 a Over 90
Adam's Sports
$
648 $ credit
405 $ balance.
198 $
45
$4,314,000
Backyard Shoe
2,345
$ 2,345
Other Customers
138,803
96,255
18,458
19,605
4,485
Total
$ 141,796 $ 96,660 $ 18,656 $ 19,650 $ 6,830
% Uncollectible
1%
4%
14%
40%
Estimated
Uncoll. Amount
$ 7,196 $
967 $
746 $ 2,751 $ 2,732
8-25
Aging of Accounts Receivable
Accounts
Debit
Bad Debt Expense (+E, -SE)
2,882,000
Allowance for Doubtful Accounts (+xA, -A)
$ 7,196,000 Desired Balance
4,314,000 Credit Balance
$ 2,882,000 Adjusting Entry
Credit
2,882,000
After posting, the
Allowance
account would
look like this . . .
8-26
Aging of Accounts Receivable
Allowance for Doubtful Accounts
6,043,000 Beg. Bal.
Write-offs 1,729,000
4,314,000 Unadj. Bal.
2,882,000 AJE
7,196,000 Adj. Bal.
Notice that the balance after
adjustment is equal to the estimate of
$7,196,000 based on the aging
analysis performed earlier.
8-27
Other Issues – Account Recoveries
Collections of accounts previously written off require
that the original write-off entry be reversed before
the cash collection is recorded.
Let’s record the entry that Skechers would make if
$50,000 is collected that had previously been
written off.
Accounts
Accounts Receivable (+A)
Allowance for Doubtful Accounts (+xA)
Cash (+A)
Accounts Receivable (-A)
Debit
50,000
Credit
50,000
50,000
50,000
8-28
Learning Objective 3
Compute and report
interest on notes
receivable.
8-29
Notes Receivable and
Interest Revenue
Accounting for notes receivable
is similar to accounting for
accounts receivable except for interest.
Accounts receivable do not
charge interest until they
become overdue, but notes
receivable start charging
interest the day they are created.
8-30
Calculating Interest
Interest
Principal
=
of the
note
×
Annual
interest
rate
×
Time
expressed
in years
Even for maturities less than 1
year, the rate is annualized.
Number of months out of twelve
that interest period covers.
8-31
Reporting Interest on
Notes Receivable
On November 1, 2007, Skechers loaned $100,000
cash and accepted a $100,000 one-year, 12
percent note. Skechers will receive the principal
and all interest earned on October 31, 2008.
Record
note
receivable
Accrue
interest
2007 Interest
11/01/07
Record interest
and principal
received
12/31/07
2008 Interest
10/31/08
8-32
Recording Notes Receivable
On November 1, 2007, Skechers loaned $100,000
cash and accepted a $100,000 one-year, 12
percent note. Skechers will receive the principal
and all interest earned on October 31, 2008.
On November 1, to record the note:
Accounts
Note Receivable (+A)
Cash (-A)
Debit
100,000
Credit
100,000
8-33
Accruing Interest Earned
On November 1, 2007, Skechers loaned $100,000
cash and accepted a $100,000 one-year, 12
percent note. Skechers will receive the principal
and all interest earned on October 31, 2008.
Interest
Principal
=
of the
note
$ 2,000 = $ 100,000
×
Annual
interest
rate
×
×
12%
×
Time
expressed
in years
2/
12
Interest revenue is
$1,000 per month.
8-34
Accruing Interest Earned
On November 1, 2007, Skechers loaned $100,000
cash and accepted a $100,000 one-year, 12
percent note. Skechers will receive the principal
and all interest earned on October 31, 2008.
On December 31, to accrue $ 2,000 interest receivable:
Accounts
Interest Receivable (+A)
Interest Revenue (+R, +SE)
Debit
2,000
Credit
2,000
8-35
Recording Interest Received
and Principal at Maturity
On November 1, 2007, Skechers loaned $100,000
cash and accepted a $100,000 one-year, 12
percent note. Skechers will receive the principal
and all interest earned on October 31, 2008.
On October 31, to record $112,000 cash received:
Accounts
Cash (+A)
Interest Revenue (+R, +SE)
Interest Receivable (-A)
Note receivable (-A)
Debit
112,000
Credit
10,000
2,000
100,000
8-36
Accounting for Uncollectible Notes
When the collection of
a note receivable is in doubt,
a company should record an
allowance for doubtful accounts
against notes receivable just
as is done with accounts
receivable.
8-37
Learning Objective 4
Compute and interpret
the receivables
turnover ratio.
8-38
Receivables Turnover Analysis
Receivables
Turnover =
Ratio
Net Credit Sales Revenue
Average Net Trade Receivables
Skechers reported 2005 net credit sales of $1,006,000,000.
December 31, 2005, receivables were $134,600,000 and
December 31, 2004, receivables were $120,400,000.
8-39
Receivables Turnover Analysis
Receivables
Turnover =
Ratio
Net Credit Sales Revenue
Average Net Trade Receivables
$1,006,000,000
=
($134,600,000 + $120,400,000) ÷ 2
= 7.9 times
This ratio measures how many times average
receivables are recorded and collected for the year.
2005 Receivables Turnover Comparisons
Boeing
11.1
Deere & Co.
6.1
Skechers
7.9
8-40
Receivables Turnover Analysis
Days to
Collect
Days to
Collect
=
365 Days
Receivables Turnover Ratio
=
365 Days
7.9
= 46.2 Days
This ratio tells us the average number of days
it takes a company to collect its receivables.
2005 Days-to-Collect Comparisons
Boeing
32.9
Deere & Co.
59.8
Skechers
46.2
8-41
Factoring Receivables
When a company desires to
quickly convert receivables
into cash, the receivables
can be sold to a financing
company or bank (called
factoring).
8-42
Credit Card Sales
Companies accept credit cards to:
1. To increase sales.
2. To avoid providing credit
directly to customers.
3. To avoid losses due to bad
checks.
4. To receive payment quicker.
When credit card sales are made, a fee is paid to
the credit card company for the service it provides.
8-43
Chapter 8
Supplement
Percentage of Credit Sales Method
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Percentage of Credit Sales
Bad debt percentage is based
on actual uncollectible accounts
from prior years’ credit sales.
Focus is on determining the amount to
record on the income statement as
Bad Debt Expense.
8-45
Percentage of Credit Sales
Net Credit Sales
 % Estimated Uncollectible
Amount of Journal Entry
8-46
Percentage of Credit Sales
In the current year Skechers had credit
sales of $1,152,800,000. Past
experience indicates that bad debts are
one-fourth of one percent (.25%) of sales.
What is the estimate of bad debt expense
for the year?
$1,152,800,000 × .0025 = $2,882,000
Let’s prepare the adjusting entry.
8-47
Percentage of Credit Sales
Accounts
Debit
Bad Debt Expense (+E, -SE)
2,882,000
Allowance for Doubtful Accounts (+xA, -A)
Credit
2,882,000
8-48
Direct Write-Off Method
No journal entries are made until a bad debt is
discovered. The following journal entry is made to
record $1,000 of bad debt expense when a customer
account is determined to be uncollectible.
Accounts
Bad Debt Expense (+E, -SE)
Accounts Receivable (-A)
Debit
1,000
Credit
1,000
Acceptable for tax purposes,
but unacceptable under generally
accepted accounting principles.
8-49
End of Chapter 8
8-50