Financial accounting the impact on decision makers 9e chapter 7

Chapter 7
Receivables and Investments


Accounts Receivable


Receivable arising from the sale of goods or services with a
verbal promise to pay



Stated on the balance sheet at net realizable, which takes into
account and estimate of the uncollectible amount (bad debts)



Two methods used in estimating bad debts:
 Percentage

of sales approach
 Percentage of receivables approach

LO 1


The Use of a Subsidiary Ledger


Assume that Apple sells $25,000 of hardware to a
school. The sale results in the recognition of an asset

and revenue


The Use of a Subsidiary Ledger


Contains the necessary detail on items that collectively make up
a single general ledger account, called the control account


Two Methods to Account for
Bad Debts


Direct write-off method: recognition of bad debts expense at
the point an account is written off as uncollectible



Allowance method: estimating bad debts on the basis of either
net credit sales or accounts receivable
 Allowance

for doubtful accounts: a contra-asset
account—reduce accounts receivable to its net
realizable value


Example 7.1—Using the Direct WriteOff Method for Bad Debts


Assume that Roberts Corp. makes a $500 sale to Dexter Inc. on
November 10, 2014, with credit terms of 2/10, n/60


Example 7.1—Using the Direct WriteOff Method for Bad Debts (continued)


Assume further that Dexter is unable to pay within 60 days. After pursuing
the account for four months into 2015, the credit department of Roberts
informs the accounting department that it has given up on collecting the
$500 from Dexter and advises that the account be written off. To do so, the
accounting department makes an adjustment


Example 7.2—Using the Allowance
Method for Bad Debts


Assume that Roberts’ total sales during 2014 amount to $600,000 and that at
the end of the year, the outstanding accounts receivable total $250,000. Also,
assume that Roberts estimates that 1% of the sales of the period, or $6,000,
will prove to be uncollectible. Under the allowance method, Roberts makes
an adjustment at the end of 2014


Example 7.2—Using the Allowance
Method for Bad Debts (continued)


Balance sheet presentation of accounts receivable
Accounts receivable
Less: Allowance for doubtful accounts
Net accounts receivable



$250,000
(6,000)
$244,000

Dexter’s $500 account is written off on May 1, 2015


Approaches to the Allowance Method
of Accounting for Bad Debts


Percentage of Net Credit Sales Approach
 Uses

the past relationship between bad debts and
net credit sales to predict bad debt amounts



Percentage of Accounts Receivable Approach
 Estimate

bad debts by relating them to the balance

in the Accounts Receivable


Example 7.3—Using the Percentage of
Net Credit Sales Approach


Assume that the accounting records for Bosco Corp. reveal the
following:

Average percentage = 2% ($153,700/$7,560,000 = 0.02033)


Example 7.3—Using the Percentage of
Net Credit Sales Approach (continued)


Assume the company uses the 2% rate and that its net
credit sales during 2014 are $2,340,000, Bosco makes
an adjustment of 0.02 × $2,340,000


Example 7.4—Using the Percentage of
Accounts Receivable Approach


Assume that the records for Cougar Corp. reveal the following:

Average percentage = 0.8% ($32,330/$4,038,000 = 0.008)

Example 7.4—Using the Percentage of
Accounts Receivable Approach (continued)


Assume balances in Accounts Receivable and
Allowance for Doubtful Accounts on December 31,
2014 is $865,000 and $2,100, respectively


Example 7.4—Using the Percentage of
Accounts Receivable Approach (continued)
 The

net realizable value of Accounts Receivable
is determined as follows:


Exhibit 7.1—Aging Schedule


Aging schedule: categorizes the various accounts according to their
length of time outstanding


Example 7.5—Using an Aging Schedule
to Estimate Bad Debts


The totals on the aging schedule are used as the basis for

estimating bad debts, as shown below


Example 7.5—Using an Aging Schedule
to Estimate Bad Debts (continued)


Assume that Allowance for Doubtful Accounts has a balance of
$1,230 before adjustment, the adjusting entry is as follows:


Accounts Receivable Turnover Ratio


Measures the number of times accounts receivable is collected
during the period

Net Credit Sales
Accounts Receivable
=
Turnover Ratio
Average Accounts Receivable

LO 2


Number of Days’ Sales in Receivables


Measures how long it takes to collect receivables

Number of Days in the Period
Number of Days’
=
Sales in Receivables
Accounts Receivable Turnover Ratio


The Ratio Analysis Model
1.

How many times a year does a company turn over its accounts
receivable?

2.

Gather the information about net credit sales and average
accounts receivable

3.

Calculate accounts receivable turnover ratio

4.

Compare the ratio with prior years and with competitors

5.

Interpret the ratios—measures how long it takes to collect

receivables


The Business Decision Model
1.
2.
3.

4.
5.

If you were a banker, would you loan money to a
company?
Gather information from the financial statements
and other sources
Compare the company's accounts receivable
turnover ratio with industry averages and look at
trends
Lend money or find an alternative use for the money
Monitor the loan periodically


Notes Receivable


Asset resulting from the acceptance of a promissory note from
another entity



Promissory note: a written promise to repay a definite sum of
money on demand or at a fixed or determinable date in the
future



Maker: party that agrees to repay the money



Payee: party that will receive the money



Note payable: a liability resulting from the signing of a
promissory note

LO 3


Summary of Relationship Between
Maker and Payee


Important Terms Connected with
Promissory Notes
Principal—the cash received, or the fair value of
the products or services received, by the maker
when a promissory note is issued
 Maturity date—the due date of promissory note

 Term—the length of time a note is outstanding
 Maturity value—the amount to be paid by the
maker on the maturity date
 Interest—the difference between the principal
amount and the maturity value
