Intermediate Accounting - Chap007 pot

Uncollectible Accounts ReceivableIn conformity with the matching principle, bad debt expense should be recorded in the same accounting period in which the sales related to the uncollec

Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved

Cash and Receivables

7

Insert Book Cover

Picture

Cash

Amounts on deposit with financial institutions

Amounts on deposit with financial institutions

Money orders

Cash Equivalents

Items very near cash but

not in negotiable form

Items very near cash but

not in negotiable form

paper

Learning Objectives

Define what is meant by internal control and describe some key elements of an internal control system for cash receipts and

disbursements.

Internal Control of Cash

Control of Cash Receipts

Separate responsibility for

 handling cash,

 recording cash transactions, and

 reconciling cash balances.

Agreed cash amounts deposited with cash

 recording cash transactions, and

 reconciling cash balances.

Agreed cash amounts deposited with cash

amounts received.

Close supervision of cash-handling and

cash-recording activities.

Control of Cash Disbursements

Separate responsibilities for

 cash disbursement documents,

Separate responsibilities for

 cash disbursement documents,

Learning Objectives

Explain the possible restrictions on cash and their implications for classification in the

balance sheet.

Restricted Cash and

Compensating Balances

Restricted Cash

Management’s intent to use a certain amount

of cash for a specific purpose – future plant

expansion, future payment of debt

Compensating Balance

Minimum balance that must be maintained

in a company’s account as support for

funds borrowed from the bank

Restricted Cash

Management’s intent to use a certain amount

of cash for a specific purpose – future plant

expansion, future payment of debt

Compensating Balance

Minimum balance that must be maintained

in a company’s account as support for

funds borrowed from the bank

Learning Objectives

Distinguish between the gross and net methods of accounting for cash discounts

Credit sales require:

 Maintaining a separate

account receivable for each

customer.

 Accounting for bad debts

that result from credit sales.

Credit sales require:

 Maintaining a separate

account receivable for each

customer.

 Accounting for bad debts

that result from credit sales.

Amounts due from

customers for credit sales.

Amounts due from

customers for credit sales.

Accounts Receivable

Number of Days Discount is Available

Number of Days Discount is Available

Otherwise, Net (or All)

is Due

Otherwise, Net (or All)

is Due

Credit Period

Credit Period

Cash Discounts

Sales are recorded at the

invoice amounts.

Sales are recorded at the

invoice

amounts.

Sales discounts are recorded if payment is received within the discount

period.

Sales discounts are recorded if payment is received within

the discount

period.

Gross Method

Cash Discounts

Sales are recorded at the

invoice amount less the

discount.

Sales are recorded at the

invoice amount less the

(a) the gross method.

(b) the net method.

On May 10, Eddy, Inc sold $5,000 of merchandise to a customer subject to a

cash discount of 1/10, n/30

Prepare the journal entry to record the sale if

Eddy uses:

(a) the gross method.

(b) the net method.

Cash Discounts

Cash Discounts

Assume that on May 19, Eddy, Inc received

a check in full payment of the sale made

on May 10

Prepare the journal entry to record the cash

receipt if Eddy uses:

(a) the gross method.

(b) the net method.

Assume that on May 19, Eddy, Inc received

a check in full payment of the sale made

on May 10

Prepare the journal entry to record the cash

receipt if Eddy uses:

(a) the gross method.

(b) the net method.

Cash Discounts

Cash Discounts

Instead of the payment on May 19, now assume that Eddy, Inc received a check on May 31, in full payment of the sale made on May 10

Prepare the journal entry to record the cash

receipt if Eddy uses:

(a) the gross method.

(b) the net method.

Instead of the payment on May 19, now assume that Eddy, Inc received a check on May 31, in full payment of the sale made on May 10

Prepare the journal entry to record the cash

receipt if Eddy uses:

(a) the gross method.

(b) the net method.

Cash Discounts

Learning Objectives

Describe the accounting treatment for

merchandise returns.

Sales Returns and Allowances

Sales Returns and Allowances

On June 1, a customer of LarCo returns

$750 of merchandise The merchandise had been purchased on account and

the customer had not yet paid LarCo

uses the periodic method to account

for inventory.

Record the journal entry for the return of

merchandise.

On June 1, a customer of LarCo returns

$750 of merchandise The merchandise had been purchased on account and

the customer had not yet paid LarCo

uses the periodic method to account

for inventory.

Record the journal entry for the return of

merchandise.

Sales Returns and Allowances

Sales Returns and Allowances is a contra

account that reduces Sales Revenue in the

current accounting period.

Learning Objectives

Describe the accounting treatment of anticipated uncollectible accounts receivable.

Uncollectible Accounts Receivable

Bad debts result from credit customers who

are unable to pay the amount they owe,

regardless of continuing collection efforts.

are unable to pay the amount they owe,

regardless of continuing collection efforts.

PAST DUE

Uncollectible Accounts Receivable

In conformity with the matching principle, bad debt expense should be

recorded in the same accounting period in which the sales related to the

uncollectible account were recorded.

In conformity with the matching principle, bad debt expense should be

recorded in the same accounting period in which the sales related to the

uncollectible account were recorded.

Uncollectible Accounts Receivable

Most businesses record an estimate of the

bad debt expense by an adjusting entry

at the end of the accounting period.

Most businesses record an estimate of the

bad debt expense by an adjusting entry

at the end of the accounting period.

Date Description

Post

Ref Debit Credit

Dec 31 Bad Debt Expense ####

Allowance for Uncollectible ####

Accounts

Uncollectible Accounts Receivable

Date Description

Post

Ref Debit Credit

Dec 31 Bad Debt Expense ####

Allowance for Uncollectible ####

Allowance for Uncollectible Accounts

Net realizable value is the amount of

the accounts receivable that the business expects to collect.

Learning Objectives

Describe the two approaches

to estimating bad debts.

 Income Statement Approach

 Balance Sheet Approach

Composite Rate

Aging of Receivables

 Income Statement Approach

 Balance Sheet Approach

Income Statement Approach

 Focuses on past credit sales to make

estimate of bad debt expense.

 Emphasizes the matching principle by

estimating the bad debt expense associated

with the current period’s credit sales.

 Focuses on past credit sales to make

estimate of bad debt expense.

 Emphasizes the matching principle by

estimating the bad debt expense associated

with the current period’s credit sales.

Bad debts expense is

In 2006, MusicLand has

credit sales of $400,000 and

estimates that 0.6% of credit

sales are uncollectible.

What is Bad Debts Expense

for 2006?

Income Statement Approach

MusicLand computes estimated Bad Debts Expense of $2,400.

Income Statement Approach

Balance Sheet Approach

 Focuses on the collectibility of accounts

receivable to make the estimate of

uncollectible accounts.

 Involves the direct computation of the

desired balance in the allowance for

uncollectible accounts

 Focuses on the collectibility of accounts

receivable to make the estimate of

uncollectible accounts.

 Involves the direct computation of the

desired balance in the allowance for

uncollectible accounts

 Compute the desired balance in the Allowance for

Uncollectible Accounts.

 Bad Debts Expense is computed as:

Balance Sheet Approach

Composite Rate

On Dec 31, 2006, MusicLand

has $50,000 in Accounts

Receivable and a $200 credit

balance in Allowance for

balance in Allowance for

Desired balance in Allowance

for Uncollectible Accounts

Balance Sheet Approach

Composite Rate

Now, let’s look at the accounts

receivable

aging

approach!

 Year-end Accounts Receivable is

broken down into age classifications.

 Year-end Accounts Receivable is

broken down into age classifications.

 Each age grouping has a different

likelihood of being uncollectible.

 Each age grouping has a different

likelihood of being uncollectible.

 Compute desired uncollectible amount.

 Compute desired uncollectible amount.

Balance Sheet Approach

Aging of Receivables

 Compare desired uncollectible amount

with the existing balance in the

allowance account.

 Compare desired uncollectible amount

with the existing balance in the

allowance account.

  

At December 31, 2006, the receivables for

EastCo, Inc were categorized as follows:

Balance Sheet Approach

Aging of Receivables

EastCo’s unadjusted balance

in the allowance account is

$500.

Per the previous computation,

the desired balance is $1,350.

EastCo’s unadjusted balance

in the allowance account is

$500.

Per the previous computation,

the desired balance is $1,350.

Prepare the entry to record bad debts

expense at Dec 31, 2006



Balance Sheet Approach

Aging of Receivables

Balance Sheet Approach

Aging of Receivables

EastCo’s unadjusted balance

in the allowance account is

$500.

Per the previous computation,

the desired balance is $1,350.

EastCo’s unadjusted balance

in the allowance account is

$500.

Per the previous computation,

the desired balance is $1,350.



Balance Sheet Approach

Balance Sheet Approach

Emphasis on Realizable Value

Emphasis on Realizable Value

Income Statement Focus

Income Statement Approach

Emphasis on Matching

Emphasis on Matching

Sales

Bad Debts Exp.

Methods to Estimate Bad Debts

Uncollectible Accounts

As accounts become uncollectible, the

following entry is made:

Post

Ref Debit Credit

Allowance for Uncollectible Accounts ####

Accounts Receivable ####

So what happens if someone pays after a write-off

of the accounts receivable?

GENERAL JOURNAL Page 69

When a customer makes a payment after an

account has been written off, two journal

entries are required.





If uncollectible accounts are immaterial, bad

debts are simply recorded as they occur

(without the use of an allowance account)

If uncollectible accounts are immaterial, bad

debts are simply recorded as they occur

(without the use of an allowance account)

Direct Write-off Method

Learning Objectives

Describe the accounting treatment of

short-term notes receivable.

PROMISSORY NOTE

after date I I promise to pay to the order of

Westward, Inc

Dollars plus interest at the annual rate of

One year

12%

Twenty-five thousand and

no/100 -Janet Lee , Winn,Co

Maker

Payee Principal

Interest Rate

Date of Note Term

Notes Receivable

Even for maturities less than 1 year, the rate is annualized.

Even for maturities less than 1 year, the rate is annualized.

Interest Computation

Interest-Bearing Notes

On November 1, 2006, Westward, Inc loans

$25,000 to Winn, Co The note bears interest at 12% and is due on November 1,

2007.

Prepare the journal entry on November 1,

2006, December 31, 2006, (year-end) and

November 1, 2007 for Westward.

Interest-Bearing Notes

Interest-Bearing Notes

$25,000 × 12% = $3,000 - $500 = $2,500

Noninterest-Bearing Notes

 Actually do bear interest.

 Interest is deducted (discounted) from the face value of the note.

 Cash proceeds equal face value of note less discount.

Noninterest-Bearing Notes

On January 1, 2006, Westward, Inc accepted

a $25,000 noninterest-bearing note from Winn, Co as payment for a sale The note is

discounted at 12% and is due on December

31, 2006.

Prepare the journal entries on January 1,

2006, and December 31, 2006 for Westward.

On January 1, 2006, Westward, Inc accepted

a $25,000 noninterest-bearing note from

Winn, Co as payment for a sale The note is

discounted at 12% and is due on December

31, 2006.

Prepare the journal entries on January 1,

2006, and December 31, 2006 for Westward.

Jan 1 Notes Receivable 25,000

Discount on Notes Receivable 3,000 Sales Revenue 22,000

Learning Objectives

Differentiate between the use of receivables

in financing arrangements accounted for

as a secured borrowing and those

accounted for as a sale.

Financing With Receivables

Secured borrowing

or Sale of receivables

Secured borrowing

or Sale of receivables

Method depends on the

surrender of control over

the receivables transferred.

Method depends on the

surrender of control over

the receivables transferred.

Secured Borrowing – Assigning

 The use of specific receivables for

collateral, and the promise that any

failure to repay debt will result in

proceeds from specific accounts

receivable collections being used to

repay the debt.

 Reclassify Accounts Receivable as

Accounts Receivable Assigned

 The use of specific receivables for

collateral, and the promise that any

failure to repay debt will result in

proceeds from specific accounts

receivable collections being used to

repay the debt.

 Reclassify Accounts Receivable as

Accounts Receivable Assigned

Secured Borrowing – Pledging

 Receivables in general are pledged as

collateral for loans

 Pledged receivables are disclosed in notes

to the financial statements.

 Receivables in general are pledged as

collateral for loans

 Pledged receivables are disclosed in notes

to the financial statements.

Sale of Accounts Receivable

FACTOR (Transferee)

ts R ec eiv

A factor is a financial institution that buys receivables

for cash, handles the billing and collection of the receivables and charges a fee for the service.

A factor is a financial institution that buys receivables

for cash, handles the billing and collection of the receivables and charges a fee for the service.

Treat as a sale if all of these conditions are met:

 Receivables are isolated from transferor.

 Transferee has right to pledge or exchange

receivables.

 Transferor does not have control over the

receivables.

 Transferor cannot repurchase

receivable before maturity.

 Transferor cannot require return

of specific receivables.

Treat as a sale if all of these conditions are met:

 Receivables are isolated from transferor.

 Transferee has right to pledge or exchange

receivables.

 Transferor does not have control over the

receivables.

 Transferor cannot repurchase

receivable before maturity.

 Transferor cannot require return

of specific receivables.

Sale of Accounts Receivable

Sale of Accounts Receivable

Without recourse

 An ordinary sale of receivables to the factor.

 Factor assumes all risk of uncollectibility

 Control of receivable passes to the factor.

 Receivables are removed from the books,

cash is received and a financing expense or loss is recognized.

Without recourse

 An ordinary sale of receivables to the factor.

 Factor assumes all risk of uncollectibility

 Control of receivable passes to the factor.

 Receivables are removed from the books,

cash is received and a financing expense or

loss is recognized.