Chapter 7 Reporting and Analyzing Receivables Accounts Receivable Accounts receivable are amounts due from customers for credit sales o Occurs when customers use credit cards or a company gives credit directly to customers o When a company extends credit directly to customers it maintains a separate accounts receivable for each customer and accounts for bad debts from credit sales Accounts receivable ledger a supplementary record created to maintain a separate account for each customer Schedule of accounts receivable shows that the balance of accounts receivable in the general ledger is the total of its individual customer balances Reasons why a company does not extent credit directly to customers and instead allows them to use 3rd party credit and debit cards o Seller does not have to evaluate each customer s credit standing or make decisions about who gets credit and how much o Seller avoids the risk of extending credit to customers who cannot pay risk is to the credit card company o Seller typically receives cash from the card company sooner than had it granted credit directly to the customer o A variety of credit options for customers offers a potential increase in sales volume How companies account for credit card and debit card sales o Debit cards some credit cards credit a seller s cash account immediately upon deposit o Credit cards require the seller to remit a copy of each receipt to the card company until payment is received the seller has an account receivable from the card company o In both cases the seller pays a fee for the services provided by the o Cash received immediately on deposit to record credit sales less a 4 card company credit card expense Debit cash 96 Debit card expense 4 Credit sales 100 4 credit card expense o Cash received some time after deposit to record credit card sales less Debit Accounts receivable credit card company 96 Debit credit card expense 4 Credit sales 100 o Cash received some time after deposit to record cash receipt Debit Cash 96 Credit accounts receivable credit card company 96 o Some companies report credit card sales on the income statement as a type of discount subtracted from sales to get net sales o Other companies say it is a selling expense or administrative expense Installment sales receivables o Amounts owed by customers from credit sales for which payment is required in periodic amounts over an extended period of time o Source documents include sales slips or invoices describing the sales transaction Bad debts when the company directly grants credit to its customers and expects that some customers will not pay what they promised aka uncollectible accounts the total amount of uncollectible accounts is an expense of selling on credit Some companies sell directly on credit anyways because they believe it will increase total sales net income enough to set off the bad debts Two Methods to account for uncollectible accounts direct write off method and allowance method Valuing Accounts Receivable Direct Write off Method o Direct write off method records the loss from an uncollectible account receivable when it is determined to be uncollectible No attempt is made to predict bad debts expenses Debit bad debts expense Credit accounts receivable If an account that was written off directly is later collected in full two entries happen Debit accounts receivable credit bad debts expense to reinstate account previously written off Debit cash credit accounts receivable to record full payment of account Companies must weigh at least 2 accounting concepts when considering the use of the direct write off method Matching expense recognition principle requires expenses to be reported in the same accounting period as the sales they helped produce hard to match bad debts expense with the sales it produced bc bad debts are not recognized right away in the same period so a company would need to estimate Materiality constraint states that an amount can be ignored if its effect on the financial statements is unimportant to users business decisions Valuing Accounts Receivable Allowance Method o Allowance method matches the estimated loss from uncollectible accounts receivable against the sales they helped produce o 2 advantages it records estimated bad debts expense in the period when the related sales are recorded it reports accounts receivable on the balance sheet at the estimated amount of cash to be collected o Realizable value refers to the expected proceeds from converting an asset into cash 20 000 accounts receivable estimate that 1 500 will not be paid realizable value is 18 500 o Allowance for doubtful accounts is a contra asset account Subtracted from the accounts receivable on the balance sheet o When specific accounts are identified as uncollectible they are written off against the allowance for doubtful accounts Debit allowance for doubtful accounts Credit accounts receivable person s name Write off does not affect the realizable value total assets and net income are not affected Net income and total assets ARE affected in the period when bad debts expense is predicted and recorded with an adjusting entry o When someone who was recorded as uncollectible actually pays Debit accounts receivable person s name credit allowance for doubtful accounts Debit cash credit accounts receivable person s name o Estimating Bad Debts Percent of Sales Method aka income statement method based on the idea that a given percent of a company s credit sales for the period is uncollectible good at matching bad debts expense with sales Percent of Receivables Method aka balance sheet method use balance sheet relations to estimate bad debts mainly the relation between accounts receivable and the allowance amount good at reporting accounts receivable at realizable value The estimated balance for the allowance account is obtained by computing the percent uncollectible from the total accounts receivable or by aging accounts receivable Percent of accounts receivable method assumes that a given percent of a company s receivables is uncollectible Aging of receivables method uses both past and current receivables information to estimate the allowance amount Unadjusted debit balance 500 estimated balance 2 270 so required adjustment 2 770 Unadjusted credit balance 200 estimated balance 2 270 so required adjustment 2 070 o Summary of Estimating Bad Debts o Notes Receivable Promissory note is a written promise to pay a specified amount of money usually with interest
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