Needles ch07

36
Chapter 7 Cash and Receivables Skyline College Lecture Notes

Transcript of Needles ch07

Page 1: Needles ch07

Chapter 7

Cash and Receivables

Skyline College

Lecture Notes

Page 2: Needles ch07

7–2Copyright © Houghton Mifflin Company. All rights reserved.

Pivotal Issues When Managing Cash and Receivables

1. Cash needs

2. Credit policies

3. Level of accounts receivable

4. Financing receivables

5. Ethical estimates on credit sale losses

Page 3: Needles ch07

7–3Copyright © Houghton Mifflin Company. All rights reserved.

Cash Considerations

Consists of: Currency and coins on

hand

Most liquid of all assets Central to operating cycle

Checks and money orders from customers

Deposits in checking and savings accounts

Cash may include a compensating balance—a minimum amount required

by a bank for a credit-granting agreement.

Page 4: Needles ch07

7–4Copyright © Houghton Mifflin Company. All rights reserved.

Cash Requirements

Seasonal Cycles and Cash Requirements for a Manufacturer of Athletic Sportswear

Page 5: Needles ch07

7–5Copyright © Houghton Mifflin Company. All rights reserved.

Credit Policies

The credit department: Examines the financial resources and debts of the

credit applicant Asks for personal references Gets credit rating from credit bureaus Determines the extent to which the company can

grant credit, if any

To increase the likelihood of selling to customers who will pay on time, companies develop control procedures and

maintain a credit department

Page 6: Needles ch07

7–6Copyright © Houghton Mifflin Company. All rights reserved.

Evaluating the Level of Accounts Receivable

How many times, on average, does a company turn its receivables into

cash during an accounting period?

How long, on average, does it take a company to collect its accounts receivables?

Receivable Turnover Days’ Sales Uncollected

Page 7: Needles ch07

7–7Copyright © Houghton Mifflin Company. All rights reserved.

Receivable Turnover

Reflects the relative size of a company’s accounts receivable and the success of its credit and

collection policies

Receivable Turnover = Net Sales

Average Net Accounts Receivable

$12,253.1

($2,120.2 + $2,083.9) ÷ 2

Nike’s ReceivableTurnover for 2004

(Amounts in Millions)

=

= 5.8 times

Page 8: Needles ch07

7–8Copyright © Houghton Mifflin Company. All rights reserved.

Nike’s Days’ Sales Uncollected =

Days’ Sales Uncollected

Days’ Sales Uncollected =

365 days

Receivable Turnover

365 days

5.8

= 62.9 days

To interpret a company’s ratios, take into consideration the industry in which it operates

Page 9: Needles ch07

7–9Copyright © Houghton Mifflin Company. All rights reserved.

Receivable Turnover for Selected Industries

Page 10: Needles ch07

7–10Copyright © Houghton Mifflin Company. All rights reserved.

Financing Receivables

Money tied up in receivables is something that many companies seek to avoid

Companies may use one or more of these methods so that they can receive cash faster:

Set up a separate finance company

Borrow money and pledge A/R

In case of default on loan, A/R (collateral) can be taken and converted to cash to satisfy the loan

FactorA/R

Sale or transfer of A/R; the buyer may bear risk of collection (factoring without recourse) or the seller may bear risk of collection (factoring with recourse)

Ford Ford Motor Credit CompanyGM General Motors Acceptance Corp. Sears Sears Roebuck Acceptance Corp.

Page 11: Needles ch07

7–11Copyright © Houghton Mifflin Company. All rights reserved.

How Factoring Works

Page 12: Needles ch07

7–12Copyright © Houghton Mifflin Company. All rights reserved.

Factoring Details

Reports a contingent liability (a potential debt that can develop if customers don’t pay receivables)

What does the seller of receivables with recourse report in financials?

Typically 2% of total A/R for sales with recourse; Higher fee for sales without recourse

What fees are charged?

Page 13: Needles ch07

7–13Copyright © Houghton Mifflin Company. All rights reserved.

Securitization

A company may sell a group of receivables in a batch at a discount to another company or to investors

When receivables are paid, buyer gets full amount, thus their profit depends on the amount of discount they negotiated

Circuit CitySells its receivables without recourse, so it has no further liability even if customers

do not pay

Page 14: Needles ch07

7–14Copyright © Houghton Mifflin Company. All rights reserved.

Discounting

The sale of promissory notes held as notes receivable

Company AHolds $10,000 note

payable to Company B; Note will pay $600 in

interest If Company B pays, bank will receive $10,600 and realize a $1,000 profit

If Company B defaults, Company A is liable for the note

Company A should disclose the contingent liability (in the amount of note plus interest) in notes to its financial statements

BankBuys the note for

$9,600

Page 15: Needles ch07

7–15Copyright © Houghton Mifflin Company. All rights reserved.

Estimating Uncollectibles

There will always be customers who do not pay their accounts, called uncollectible accounts, or bad debts

Match these expenses of selling on credit to the revenues they help generate

Estimate the uncollectible expense in the fiscal year

in which the sales are made

Page 16: Needles ch07

7–16Copyright © Houghton Mifflin Company. All rights reserved.

Estimating Uncollectibles and Ethics

Because estimations are involved, earnings may be easily manipulated…

earnings are understated.

If the amount of losses from uncollectible accounts

are overstated,

earnings are overstated. If the amount of losses

from uncollectible accounts are understated,

Page 17: Needles ch07

7–17Copyright © Houghton Mifflin Company. All rights reserved.

Discussion: Ethics in the World

WorldCom increased revenues and hid losses by continuing to bill customers for service for years after the customers had stopped paying.

Q. What impact do you think WorldCom’s actions had on Accounts Receivable and Sales?

Page 18: Needles ch07

7–18Copyright © Houghton Mifflin Company. All rights reserved.

Cash Equivalents

Investments like time deposits or certificates of deposit (CDs) that have a term of 90 days or less

Nike’s Annual Report, 2005Cash and equivalents represent cash and short-term, highly liquid investments with original maturities of three months or less at the time of purchase. The carrying amounts reflected in the consolidated balance sheet for cash and equivalents approximate fair value due to their short maturities.

Page 19: Needles ch07

7–19Copyright © Houghton Mifflin Company. All rights reserved.

Cash Control: Electronic Funds Transfer (EFT)

Method of conducting business transactions in which funds are transferred electronically

from one bank to another bank

Wal-Mart makes 75% of its

payments to suppliers using

EFT

Electronic Banking

ATM transactionsDebit and credit card purchases

Online bill-pay

Page 20: Needles ch07

7–20Copyright © Houghton Mifflin Company. All rights reserved.

Direct Charge-Off Method

Recognize a loss at the time it is determined that an account is uncollectible

Date Uncollectible Accounts Expense XXX

Accounts Receivable XXX

Tax law requires use of this method when computing taxable income

Most companies do not use this method for financial reporting purposes because it does not conform to GAAP.

Page 21: Needles ch07

7–21Copyright © Houghton Mifflin Company. All rights reserved.

The Allowance Method

Losses from bad debts are matched against the sales they help generate

At the time of sale, management cannot identify which customers will not pay

To observe the matching rule, losses from uncollectible accounts must be estimated

The estimate becomes an expense in the fiscal year in which the sales are made

Page 22: Needles ch07

7–22Copyright © Houghton Mifflin Company. All rights reserved.

Alternate Account Names

Allowance for Uncollectible Accounts

Uncollectible Accounts Expense

Allowance for Doubtful Accounts

Allowance for Bad Debts

Bad Debts Expense

Page 23: Needles ch07

7–23Copyright © Houghton Mifflin Company. All rights reserved.

Estimating Uncollectible Accounts

• Estimated loss should be: Realistic Based on objective information Based on past experience Based on current economic conditions

Two commonly used methods for

estimating loss

1. Percentage of net sales method

2. Accounts receivable aging method

Page 24: Needles ch07

7–24Copyright © Houghton Mifflin Company. All rights reserved.

Percentage of Net Sales Method

How much of this year’s net sales will not be collected?

The answer determines the amount of uncollectible accounts expense for the year

The percentage amount is ususally based on the company’s historic losses

It ignores the difference between last year’s estimated losses and the actual losses incurred during the year

Page 25: Needles ch07

7–25Copyright © Houghton Mifflin Company. All rights reserved.

Dec. 31, 20x9: Account balances: Sales, $645,000; Sales Returns and Allowances, $40,000; Sales Discounts, $5,000; Allowance for Uncollectible Accounts, $3,600. Management estimates that uncollectible accounts will average about 2 percent of net sales.

$12,000 $5,000)– $40,000– ($645,000 x .02 expense accounts bleUncollecti ==

Allowance for Uncollectible Accounts

Dec. 31 3,600Dec. 31 adj. 12,000

Dec 31 bal. 15,600

Percentage of Net Sales Method

After the above entry is posted, Allowance for

Uncollectible Accounts will have a credit balance of

$15,600

Dec. 31 Uncollectible Accounts Expense 12,000 Allowance for Uncollectible Accounts 12,000 To record the uncollectible accounts

expense at 2 percent of $600,000 net sales

Page 26: Needles ch07

7–26Copyright © Houghton Mifflin Company. All rights reserved.

Accounts Receivable Aging Method

How much of the ending balance of accounts receivable will not be collected?

The ending balance of Allowance for Uncollectible Accounts is determined directly through an analysis of accounts receivable

The difference between the amount determined to be uncollectible and the actual balance of Allowance for Uncollectible Accounts is the expense for the period.

Page 27: Needles ch07

7–27

Notice that the estimated percentage uncollectible increases as accounts become further past due.

Analysis of Accounts Receivable by Age

The total past due for each category is multiplied by the estimated percentage uncollectible

The sum of the totals for each category is the estimated balance of Allowance for Uncollectible Accounts

Gail Mestas, 10/23/2002
Insert Exhibit 1, chapter 7, Financial Accounting,8e, Needles,titled "Analysis of Accounts REceivable by Age"Without the exhibit, it is difficult for me to tell where the two boxes should be placed on the slide. Please palce boxes where appropriateOrder of appearance:1. Exhibit2. Box - Bullets, no background or outline3. Box - Ornage and outlined
Page 28: Needles ch07

7–28Copyright © Houghton Mifflin Company. All rights reserved.

Accounts Receivable Aging Method (Case 1)

Dec. 31, 20x6: Management has estimated that $2,459 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a credit balance of $800.

Allowance for Uncollectible Accounts

A credit adjustment of $1,659 will bring the account to its target balance

Dec. 31 800Dec. 31 adj. 1,659

Dec. 31 bal. 2,459

The target balance for the account is $2,459

Dec. 31 Uncollectible Accounts Expense 1,659 Allowance for Uncollectible Accounts 1,659 To bring the allowance for uncollectible

accounts to the level of estimated losses

Page 29: Needles ch07

7–29Copyright © Houghton Mifflin Company. All rights reserved.

Accounts Receivable Aging Method (Case 2)

Dec. 31, 20x6: Management has estimated that $2,459 of Accounts Receivable are uncollectible. Allowance for Uncollectible Accounts has a debit balance of $800.

Allowance for Uncollectible Accounts

A credit adjustment of $3,259 will bring the account to its target balance

Dec. 31. 800Dec. 31 adj. 3,259

Dec. 31 bal. 2,459

The target balance for the account is $2,459

Dec. 31 Uncollectible Accounts Expense 3,259 Allowance for Uncollectible Accounts 3,259 To bring the allowance for uncollectible

accounts to the level of estimated losses

Page 30: Needles ch07

7–30Copyright © Houghton Mifflin Company. All rights reserved.

Comparison of Two Methods

Page 31: Needles ch07

7–31Copyright © Houghton Mifflin Company. All rights reserved.

Estimates Differ from Write-Offs?

Accounts receivable written off during a period will rarely equal the estimated uncollectible amount

Shows a credit balance when the total of

accounts written off is less than the estimated uncollectible amount

Shows a debit balance when the total of

accounts written off is greater than the

estimated uncollectible amount

Allowance for Uncollectible Accounts

Page 32: Needles ch07

7–32Copyright © Houghton Mifflin Company. All rights reserved.

Writing Off an Uncollectible Account

When it becomes clear an account will not be collected, the amount should be written off to:

• Allowance for Uncollectible Accounts

• Accounts Receivable

The uncollectible amount was already accounted for as an expense when the allowance was established

Page 33: Needles ch07

7–33

Bal. 2,209

Dec. 31 2,459

Writing Off an Uncollectible

Jan. 15, 20x7: R. Deering, who owes the company $250, is declared bankrupt by federal court.

Allowance for Uncollectible Accounts

Net realizable value of A/RBefore write-off $44,400 – $2,459 = $41,941

Jan. 15 250

The write-off does not affect the estimated net realizable value of accounts receivable

Accounts Receivable

Dec. 31 44,400Jan. 15 250

Bal. 44,150

After write-off $44,150 – $2,209 = $41,941

Jan. 15 Allowance for Uncollectible Accounts 250 Accounts Receivable 250 To write off receivable from R. Deering as

uncollectible because of his bankruptcy

Page 34: Needles ch07

7–34Copyright © Houghton Mifflin Company. All rights reserved.

Making and Paying Notes

A promissory note is an unconditional promise to pay a definite sum of money on demand at a future

dateMaker

Person or company that signs the note and

promises to pay the amount

PayeeEntity to whom

payment is to be made

All promissory notes that the payee holds that are due in less than one year are categorized as notes receivable in the current

assets section of the balance sheet

All promissory notes that the maker holds that are due in less than one year are categorized as

notes payable in the current liability section of the balance

sheet

Page 35: Needles ch07

7–35Copyright © Houghton Mifflin Company. All rights reserved.

A Promissory Note

Page 36: Needles ch07

7–36Copyright © Houghton Mifflin Company. All rights reserved.

Key Components of Promissory Notes

Total proceeds of a note at maturity date (face value plus interest)

Maturity Value

Cost of borrowing money or the return for lending money, usually stated on an annual basis

Interest and Interest Rate

Length of time in days between the note’s issue date and its maturity date

Duration

Date on which the note must be paidMaturity Date