chapter 7 accounts and notes receivable. conceptual learning objectives self-study: c1: describe...

Chapter 7

Accounts and Notes Receivable

Conceptual Learning Objectives

Self-Study:C1: Describe accounts receivable and

how they occur and are recorded.

C2: Describe a note receivable and the computation of its maturity date and interest.

C3: Explain how receivables can be converted to cash before maturity.

7-2

Analytical Learning Objectives

A1: Compute accounts receivable turnover and use it to help assess financial condition.

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Procedural Learning Objectives

P1: Apply the direct write-off and allowance methods to account for accounts receivable.

P2: Estimate uncollectibles using methods based on sales and accounts receivable.

P3: Record the receipt of a note receivable.

P4: Record the honoring and dishonoring of a note and adjustments for interest.

7-4

Accounts Receivable

Amounts due from customers for credit

sales (2/10, n/30).

Credit sales require: Maintaining a separate account

receivable for each customer.

Accounting for bad debts that result from credit sales.

C 1

7-5

Recognizing Accounts ReceivableC 1

$4.3 Mil.

$9.392 Mil.

$118 Mil.

$109 Mil.

Percentage of total assets

7-6

Accounts Receivable

Sales on Credit => A/RCredit sales are recorded by increasing (debiting) Accounts Receivable.

a. The General Ledger Account continues to keep a single Accounts Receivable account.

b. A supplementary record, called the accounts receivable ledger account, is created to maintain a separate account for each customer.

c. The sum of the individual (subsidiary) accounts in the accounts receivable ledger equals the debit

balance of the Accounts Receivable account in the general ledger (Master Account).

On July 16, Barton, Co. sells $950 of merchandise on credit to Webster, Co., and $1,000 of merchandise on account to Matrix, Inc.

On July 16, Barton, Co. sells $950 of merchandise on credit to Webster, Co., and $1,000 of merchandise on account to Matrix, Inc.

Sales on Credit

Jul. 16 Accounts Receivable - Webster 950 Sales 950

To record credit sales to Webster Co.

Accounts Receivable - Matrix 1,000 Sales 1,000

To record credit sales to M atrix, Inc.

C 1

7-8

Sales on Credit

Date PR Debit Credit BalanceJul. 16 950 950

Matrix, Inc.Date PR Debit Credit BalanceJul. 16 1,000 1,000

Accounts Receivable LedgerWebster, Co.

Webster, Co. 950$ Matrix, Inc. 1,000 Total 1,950$

Schedule ofAccounts Receivable

Date PR Debit Credit BalanceJul. 16 1,950 1,950

General LedgerAccounts Receivable

C 1

7-9

On July 31, Barton, Co. collects $500 from Webster, Co., and $800 from Matrix, Inc. on account.

On July 31, Barton, Co. collects $500 from Webster, Co., and $800 from Matrix, Inc. on account.

Sales on Credit

Jul. 31 Cash 500 Accounts Receivable - Webster 500

To record cash collections on account

Cash 800 Accounts Receivable - Matrix 800

To record cash collections on account

C 1

7-10

Sales on Credit

Date PR Debit Credit BalanceJul. 16 950 950 Jul. 31 500 450

Matrix, Inc.Date PR Debit Credit BalanceJul. 16 1,000 1,000 Jul. 31 800 200

Accounts Receivable LedgerWebster, Co.

Webster, Co. 450$ Matrix, Inc. 200 Total 650$

Schedule ofAccounts Receivable

Date PR Debit Credit BalanceJul. 16 1,950 1,950 Jul. 31 1,300 650

General LedgerAccounts Receivable

C 1

7-11

Exercise 2

Advantages of allowing customers to use credit cards:

Customers’ credit is

evaluated by the credit

card issuer.

Customers’ credit is

evaluated by the credit

card issuer.

The risks of extending credit are transferred to the credit card issuer.

The risks of extending credit are transferred to the credit card issuer.

Cash collections are quicker.

Cash collections are quicker.

Sales increase by providing purchase

options to the customer.

Sales increase by providing purchase

options to the customer.

Credit Card SalesC 1

7-13

With bank credit cards, the seller deposits the credit card sales receipt in the bank just like it deposits a customer’s check.

With bank credit cards, the seller deposits the credit card sales receipt in the bank just like it deposits a customer’s check.

The bank increases the balance in the company’s checking account.

The bank increases the balance in the company’s checking account.

The company usually pays a fee of 1% to 5% for the service.

The company usually pays a fee of 1% to 5% for the service.

Credit Card SalesC 1

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On July 16, 2009, Barton, Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 2%.

The cash is received immediately.

On July 16, 2009, Barton, Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 2%.

The cash is received immediately.

Credit Card Sales(Immediate receipt of cash)

Jul. 16 Cash 490 Credit Card Expense 10

Sales 500 To record credit card sales

and fees

C 1

7-15

On July 16, 2009, Barton, Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 1%. Barton remits the credit card sale to the credit card company and waits for the payment that is received on July 28.

On July 16, 2009, Barton, Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 1%. Barton remits the credit card sale to the credit card company and waits for the payment that is received on July 28.

Credit Card Sales (Delayed receipt of Cash)

DR CRJul. 16 Accounts Receivable - Credit Card Co. 495

Credit Card Expense 5 Sales 500

To record credit card sales and fees.

Jul. 28 Cash 495

Accounts Receivable - Credit Card Co. 495

To record receipt from credit card company 7-16

Quick Study 1

Exercise 1

Installment Accounts Receivable

Amounts owed by customers from credit sales for which payment is required in periodic amounts over an extended time period. The customer is usually charged interest.

C 1

7-18

The Matching Principle requires expenses to be reported in the same accounting period as the sales they help to produce.

Some customers may not pay their account.

-Uncollectible amounts are referred to as bad debts.

-There are two methods of accounting for bad debts: Direct Write-Off Method (Violates MATCHING) Allowance Method (Based on MATCHING)

- % of Sales method => I/S Approach- % of Receivables method => B/S

Approach

Some customers may not pay their account.

-Uncollectible amounts are referred to as bad debts.

-There are two methods of accounting for bad debts: Direct Write-Off Method (Violates MATCHING) Allowance Method (Based on MATCHING)

- % of Sales method => I/S Approach- % of Receivables method => B/S

Approach

Valuing Accounts ReceivableP1

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Direct Write-Off Method

The direct write-off method:Records the loss from an uncollectible

account receivable when it is determined to be uncollectible. || Violates MATCHING Principle

a. Entry to write off uncollectible and recognize loss: Debit: Bad Debt Expense Credit: Accounts Receivable.

b. If a written off account is later collected, this results in a reversal of the write off (see a.) and a normal collection of account entry.

On August 4th, 2009, Barton determines it cannot collect $350 from Martin, Inc., a credit customer.Note: Sales to Martin occurred on November 10th, 2008.

On August 4th, 2009, Barton determines it cannot collect $350 from Martin, Inc., a credit customer.Note: Sales to Martin occurred on November 10th, 2008.

Direct Write-Off Method

DR CRNov.10 Accounts Receivable - Martin 350

2008 Sales 350

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DR CRAug. 4 Bad Debts Expense 350

2009 Accounts Receivable - Martin 350 To write-off uncollectible account

On September 9th, 2010, Martin decides to pay $200 that was previously written off.

On September 9th, 2010, Martin decides to pay $200 that was previously written off.

Direct Write-Off Method

DR CRSep. 9 Accounts Receivable - Martin 200

Bad Debts Expense 200 To reinstate account previously written-off

Sep. 9 Cash 200 Accounts Receivable - Martin 200

To record payment on account

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If a written off account is later collected, this results in a reversal of the write off (see Aug. 4th, 2009 entry) and a normal collection of account entry.

Matching vs. Materiality

The Matching Principle requires expenses to be reported in the same accounting period as the sales they help to produce.

The Matching Principle requires expenses to be reported in the same accounting period as the sales they help to produce.

The Materiality Constraint states that an amount can be ignored if its effect on the financial statements is unimportant to users’ business decisions.

The Materiality Constraint states that an amount can be ignored if its effect on the financial statements is unimportant to users’ business decisions.

P1

7-24

Matching vs. Materiality

Under the matching principle, the direct write-off method usually does not best match sales and expenses.

But, the materiality constraint permits the use of the direct write-off method when bad debts expenses are very small in relation to a company’s other financial statement items.

At the end of each period, estimate totalbad debts expected to be realized from That period’s sales.

There are two advantages to the allowance method:

1. It records estimated bad debts expense in the period when the related sales are recorded.

=> Proper matching of Expenses with Income on I/S;

2. It reports accounts receivable on the balance sheet at the estimated amount (Realizable value) of cash to be collected.

=> Proper VALUATION of A/R on Balance Sheet.

At the end of each period, estimate totalbad debts expected to be realized from That period’s sales.

There are two advantages to the allowance method:

1. It records estimated bad debts expense in the period when the related sales are recorded.

=> Proper matching of Expenses with Income on I/S;

2. It reports accounts receivable on the balance sheet at the estimated amount (Realizable value) of cash to be collected.

=> Proper VALUATION of A/R on Balance Sheet.

Allowance Method

7-26

Recording Bad Debts Expense

Bal. 278,000Accounts Receivable

Jan. 1 0BDE 3,000Dec. 31 3,000

Allowance for Doubtful Accounts

DR CRDec. 31 Bad Debts Expense 3,000

Allowance for Doubtful Accounts 3,000 To record estimated bad debts

At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2009, is $278,000.

At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2009, is $278,000.

Contra-asset accountContra-asset account

7-27

Recording Bad Debts Expense

DR CRCashAccounts receivable 278,000$ Less: Allowance for doubtful accounts 3,000 275,000$

Barton, Co.Partial Balance Sheet

December 31, 2009

At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2009, is $278,000.

At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2009, is $278,000.

7-28

Two Methods

1. Percent of Sales Method

2. Accounts Receivable Methods Percent of Accounts Receivable Method Aging of Accounts Receivable Method

Two Methods

1. Percent of Sales Method

2. Accounts Receivable Methods Percent of Accounts Receivable Method Aging of Accounts Receivable Method

Allowance Method of estimating

Bad Debts Expenses

7-29

Barton has credit sales of $1,400,000 in 2009. Management estimates 0.5% of credit sales will eventually prove uncollectible.

What is Barton’s Bad Debts Expense for 2009?

Percent of Sales Method

Bad debts expense is computed as follows:

7-30

Barton’s accountant computes estimated

Bad Debts Expense of $7,000.

Percent of Sales Method

DR CRDec. 31 Bad Debts Expense 7,000

Allowance for Doubtful Accounts 7,000 To record estimated bad debts

P2

7-31

Percent of Sales MethodBarton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on Dec.31, 2009.

What is the balance in AFDA on Dec. 31, 2009?

Prepare the ‘T’ accounts for A/R and AFDA showing the balances as of 12/31/09.

Bal. 100,000Accounts Receivable

Dec. 31 900BDE 7,000Dec. 31 7,900

Allowance for Doubtful Accounts

DR CRCashAccounts receivable 100,000$ Less: Allowance for doubtful accounts 7,900 92,100$

Barton, Co.Partial Balance Sheet

December 31, 2009

Quick Study 4;

Exercise 4: -% of Sales;-Partial B/S

Exercise 9a: -% of Sales;-Partial B/S.

Exercise 9b: -% of Sales;-Partial B/S

Percent of Sales Method

Compute the estimate of the Allowance for Doubtful Accounts:

Bad Debts Expense is computed as:

Percent of Accounts Receivable Method

7-34

Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on December 31, 2009.

Past experience suggests that 4% of receivables are uncollectible.

What is Barton’s Bad Debts Expense for 2009?

What is the balance in AFDA on Dec. 31, 2009?

Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on December 31, 2009.

Past experience suggests that 4% of receivables are uncollectible.

What is Barton’s Bad Debts Expense for 2009?

What is the balance in AFDA on Dec. 31, 2009?

Percent of Accounts Receivable

7-35

Desired balance in Allowance for Doubtful Accounts.

Percent of Accounts Receivable

DR CRDec. 31 Bad Debts Expense 3,100

Allowance for Doubtful Accounts 3,100 To record estimated bad debts

7-36

Percent of Accounts Receivable

DR CRCashAccounts receivable 100,000$ Less: Allowance for doubtful accounts 4,000 96,000$

Barton, Co.Partial Balance Sheet

December 31, 2009

Bal. 100,000Accounts Receivable

Dec. 31 900BDE 3,100Dec. 31 4,000

Allowance for Doubtful Accounts

Quick Study 3;

Exercise 5: -% of A/R;-Partial B/S;

Exercise 7: -% of A/R;-Partial B/S;

Exercise 9c: -% of A/R;-Partial B/S.

Percent of Accounts Receivable

Each receivable is grouped by how long it is past its due date.

Each receivable is grouped by how long it is past its due date.

Estimated bad debts for each group are totaled.

Estimated bad debts for each group are totaled.

Aging of Accounts Receivable Method

Each age group is multiplied by its estimated bad debts percentage.

7-39

Barton, Co.Schedule of Accounts Receivable by Age

December 31, 2009

Days Past Due

Accounts Receivable

Balance Percent

Uncollectible

Estimated Uncollectible

Amount

Not Yet Due 64,500$ 1% 645$ 1 - 30 Days Past Due 18,500 3% 555 31 - 60 Days Past Due 10,000 7% 700 61 - 90 Days Past Due 3,900 40% 1,560 Over 90 Days Past Due 3,100 60% 1,860

100,000$ 5,320$

Aging of Accounts Receivable

P2

7-40

Barton’s unadjusted balance in the allowance account is $900.

We estimated the proper balance to be $5,320.

Barton’s unadjusted balance in the allowance account is $900.

We estimated the proper balance to be $5,320.

Aging of Accounts Receivable

DR CRDec. 31 Bad Debts Expense 4,420

Allowance for Doubtful Accounts 4,420 To record estimated bad debts

P2

7-41

Exercise 6: a, b & c

Aging of Accounts Receivable

With the allowance method, when an account is determined to be uncollectible, the debit goes to Allowance for Doubtful Accounts.

With the allowance method, when an account is determined to be uncollectible, the debit goes to Allowance for Doubtful Accounts.

Writing Off a Bad Debt under the Allowance Method

Barton determines that Martin’s $300 account is uncollectible.

Barton determines that Martin’s $300 account is uncollectible.

DR CRDec. 31 Allowance for Doubtful Accounts 300

Accounts Receivable - Martin 300 To write-off an uncollectible account

7-43

Subsequent collections on accounts written off require that the original write-off entry be reversed before the cash collection is recorded.

Subsequent collections on accounts written off require that the original write-off entry be reversed before the cash collection is recorded.

Recovery of a Bad Debt

DR CRFeb. 8 Accounts Receivable - Martin 300

Allowance for Doubtful Accounts 300 To reinstate account previously written off

Feb. 8 Cash 300 Accounts Receivable - Martin 300

To record full payment on account

P2

7-44

Exercise 6 & 8

% of Sales

Emphasis on Matching

SalesBad

Debts Exp.

Income Statement

Focus

Income Statement

Focus

% of Receivables

Emphasis on Realizable Value

Accts. Rec. All. for

Doubtful Accts.

Balance Sheet Focus

Balance Sheet Focus

Aging of Receivables

Emphasis on Realizable Value

Accts. Rec. All. for

Doubtful Accts.

Balance Sheet Focus

Balance Sheet Focus

SummaryP2

7-46

$1,000.00 July 10, 2009

Ninety days

Barton Company, Los Angeles, CA

One thousand and no/100 --------------------------------- Dollars

First National Bank of Los Angeles, CA

42

12%

Julia Browne

after date I promise to pay to

the order of

Payable atValue received with interest at per annumNo. Due Oct. 8, 2009

Term

Payee

Maker

Notes ReceivableP3

Principal

Interest Rate

Due Date

7-47

If the note is expressed in days, base a year on 360

days.

If the note is expressed in days, base a year on 360

days.

Even for maturities less than one year,

the rate is annualized.

Even for maturities less than one year,

the rate is annualized.

Interest ComputationP3

7-48

On March 1, 2009, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier.

What is the maturity date of the note?

On March 1, 2009, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier.

What is the maturity date of the note?

Computing Maturity and InterestP3

7-49

Computing Maturity and Interest

Days in March 31 Minus the date of the note 1 Days remaining in March 30 Days in April 30 Days in May to maturity 30 Period of the note in days 90

The note is due and payable on May 30, 2009.

How much interest will Matrix pay to Office Supplies, Inc. on this note?

P3

7-50

Total interest due at May 30.

Computing Maturity and InterestP3

Principal of the note

×Annual interest

rate ×

Time expressed

in years = Interest

$ 12,000 × 9% × 90/360 = $ 270

7-51

Recognizing Notes Receivable

Here are the entries to record the note on March 1, and the settlement on May 30, 2009.Here are the entries to record the note on March 1, and the settlement on May 30, 2009.

DR CRMar. 1 Notes Receivable 12,000

Sales 12,000 Sold goods in exchange for note

DR CRMay 30 Cash 12,270

Interest Revenue 270 Notes Receivable 12,000

Collected note and interest due

P3

7-52

Recording a Dishonored Note

On May 30, 2009, Matrix informs us that the company is unable to pay the note or interest.On May 30, 2009, Matrix informs us that the company is unable to pay the note or interest.

Accounts Receivable - Matrix 12,270 Interest revenue 270 Notes Receivable 12,000

To charge accounts receivable for dishonored

note

P4

7-53

Recording End-of-Period Interest Adjustments

On December 1, 2009, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix issued a 9% note due in 90 days in payment for the copier. What adjusting entry is required on December 31, the end of the company’s accounting period?

On December 1, 2009, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix issued a 9% note due in 90 days in payment for the copier. What adjusting entry is required on December 31, the end of the company’s accounting period?

$12,000 × 9% × 30/360 = $90

DR CRDec. 31 Interest Receivable 90

Interest Revenue 90 To accrue interest on note

P4

7-54

Recording End-of-Period Interest Adjustments

Days in December 31 Minus the date of the note (1) Day remaining in December 30 Days in January 31 Days in February 28 Days in March until maturity 1 Period of the note in days 90

DR CRMar. 1 Cash 12,270

Interest Receivable 90 Interest Revenue 180 Notes Receivable 12,000

To record full payment of note

Recording collection on note at maturity.Recording collection on note at maturity.

P4

7-55

Quick Study: 5 & 6Exercise: 10 & 11Exercise: 12

Notes Receivable

Disposing of Receivables

Companies sometimes want to convert receivables to cash before they are due.

They can sell or factor receivables. They may pledge receivables as

security for a loan.

7-57

This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue.

This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue.

Net sales Average accounts receivable Net sales Average accounts receivable

Accounts Receivable TurnoverA1

7-58

Days’ Sales Uncollected

Days’Sales

Uncollected

Accounts Receivable Net Sales × 365=

How much time is likely to pass beforewe receive cash receipts from credit sales.How much time is likely to pass beforewe receive cash receipts from credit sales.

A1

6-59

End of Chapter 7

7-60