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Needles Powers Principles of Financial Accounting 12e Receivables 9 C H A P T E R human/iStockphoto.
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Transcript of Needles Powers Principles of Financial Accounting 12e Receivables 9 C H A P T E R human/iStockphoto.
NeedlesPowers
Principles of Financial Accounting
12e
Receivables9C H A P T E R
©human/iStockphoto
Accounts Receivable
Accounts receivable are short-term financial assets that arise from sales on credit and are often called trade credit.– In setting credit terms, a company must
keep in mind the credit terms of its competitors and the needs of its customers.
– Companies that are too lenient in granting credit can run into difficulties when customers don’t pay.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Accounts Receivable
The accounts of customers who cannot or will not pay are called uncollectible accounts (or bad debts).– There are two methods of accounting for
uncollectible accounts: Direct charge-off method: recognize a loss
when an account is determined to be uncollectible. (This is not in accordance with accrual accounting.)
Allowance method: recognize a loss at the time credit sales are made. (This is in accordance with accrual accounting.)
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Notes Receivable
Notes receivable are short-term financial assets supported by written agreements called promissory notes. – A promissory note is an unconditional
promise to pay a definite sum of money on demand or at a future date. The person or entity that signs the note and
promises to pay is the maker of the note. The entity to whom payment is to be made is
the payee.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Allowance Method: Using Accrual Accounting to Value Receivables
The allowance method is an application of accrual accounting, which requires estimated losses from bad debts to be matched with the revenue they help to produce.– It serves to value accounts receivable on the
balance sheet.– Because management cannot identify at the time
of sale which customers will not pay or how much the company will lose, losses from uncollectible accounts must be estimated, and the estimate becomes an expense in the period in which the sales are made.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Disclosure of Receivables
A payee includes all the promissory notes it holds that are due in less than one year as notes receivable in the current assets section of the balance sheet.
Any interest accrued on these notes is also included in the current assets section—as interest receivable.
Uncollectible Accounts Expense appears on the income statement as an operating expense.
Allowance for Uncollectible Accounts appears on the balance sheet as a contra account, deducted from accounts receivable in the current assets section. – It reduces the accounts receivable to the amount
expected to be collectible (net realizable value).
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Uncollectible Accounts
The allowance account is necessary because the specific uncollectible accounts will not be identified until later. The company’s accountant makes an estimate based on past experience and current economic conditions. – Two common methods of estimating
uncollectible accounts expense are: Percentage of net sales method—The basis for
this method is the amount of this year’s net sales that will not be collected.
Accounts receivable aging method—The basis for this method is the amount of the ending balance of accounts receivable that will not be collected.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Accounts Receivable Aging Method
The aging of accounts receivable is the process of listing each customer’s receivable account according to the due date of the account.– If the customer’s account is past due, there
is a possibility that the account will not be paid.
– That possibility increases as the account extends further beyond the due date.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Writing Off Uncollectible Accounts
The total of accounts receivable written off in a period will rarely equal the estimated uncollectible amount.
When it becomes clear that a specific account receivable will not be collected, the amount should be written off to Allowance for Uncollectible Accounts.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Maturity Date and Duration of a Note
The maturity date is the date on which a promissory note must be paid. This date must be stated on the note or be determinable from the facts on the note.
The duration of a note is the time between a promissory note’s issue date and its maturity date.– Interest is calculated on the basis of the
duration of a note.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Interest
Interest is the cost of borrowing money or the return on lending money, depending on whether one is the borrower or the lender. The amount of interest is based on three factors:– Principal (the amount of money borrowed or
lent)– Rate of interest– Length of the loan
The formula used in computing interest is:Principal × Rate of Interest × Time = Interest
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Maturity Value
The maturity value is the total proceeds of a promissory note—face value plus interest—at the maturity date.
The maturity value of a 90-day, 8 percent, $1,000 note is computed as follows:Maturity Value = Principal + Interest = $1,000 + ($1,000 × 8/100 × 90/365) = $1,000 + $19.73 = $1,019.73
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Accrued Interest(slide 1 of 2)
Accrued interest must be apportioned to the periods in which it belongs.
Assume that a $1,000, 90-day, 8 percent note was received on August 31 and that the fiscal year ends September 30. Interest for 30 days is calculated as follows:
Principal X Rate of Interest × Time = Interest
$1,000 × 8/100 × 30/365 = $6.58
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Accrued Interest(slide 2 of 2)
The remainder of the interest income would be calculated as follows:
Principal × Rate of Interest × Time = Interest$1,000 × 8/100 × 60/365 = $13.15
- $6.58 of the interest would be recorded as income in the fiscal year ending September 30, and the interest receivable ($6.58) would be shown as received when the note is paid.
- The remainder of the interest, $13.15, would be recorded as income in the next fiscal year.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Dishonored Note
A note not paid at maturity is called a dishonored note. – The holder, or payee, of a dishonored note
should transfer the total amount due (including interest income) from Notes Receivable to an individual account receivable for the debtor.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Receivables Turnover
The receivables turnover shows how many times, on average, a company turned its receivables into cash during a period.– It is computed by dividing net sales by the
average accounts receivable (net of allowances).
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Days’ Sales Uncollected
Day’s sales uncollected shows, on average, how long it takes to collect accounts receivable.– To determine the days’ sales
uncollected, the number of days in a year is divided by the receivables turnover.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factoring
Factoring is the sale or transfer of accounts receivable to an entity, called a factor. Factoring can be done with or without recourse.– With recourse means that the seller of the
receivables is liable to the factor if a receivable cannot be collected. In accounting terminology, a seller of receivables with
recourse is said to be contingently liable. A contingent liability is a potential liability that can develop into a real liability if a particular event occurs—in this case, a customer’s nonpayment of a receivable.
– Without recourse means that the factor bears any losses from unpaid accounts.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Securitization
Securitization is a process in which a company groups its receivables in batches and sells them at a discount to other companies or investors.– When the receivables are paid, the buyers
get the full amount.– Their profit depends on the amount of the
discount.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Discounting
Discounting is a method of financing receivables by selling promissory notes held as notes receivable to a financial lender, usually a bank.– The bank derives its profit by deducting the
interest from the maturity value of the note.
– The holder of the note endorses the note and turns it over to the bank.
– The bank expects to collect the maturity value of the note (principal plus interest), but it also has recourse against the note’s endorser.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Ethics and Estimates in Accounting for Receivables
Because the amount of uncollectible accounts can only be estimated, a company’s earnings can be easily manipulated.– Misstatements of earnings can occur simply
because of a bad estimate.– They can also be deliberately made to meet
analysts’ estimates of earnings, reduce income taxes, or meet benchmarks for bonuses.
– Companies will high ethical standards try to be accurate in their estimates of uncollectible accounts, and they disclose the basis of their estimates.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.