Acct 230 1st Edition Lecture 16Outline of Last Lecture I. Casha. Accounts for Petty Cashb. Major Inflows and Outflows of Cashc. Earnings quality by comparing net income and cash flowsOutline of Current Lecture II. Recognition of Accounts ReceivableIII. Valuation of Accounts Receivable Current LectureIV. Recognition of Accounts Receivablea. Credit salesi. Common for large business transactions in which buyers don’t have sufficient cash available or where credit cards cannot be used becausethe transaction amount exceeds typical credit card limits. ii. Revenue is recognized at the time of a credit sale.iii. An asset (accounts receivable) is recognized at the time of a credit sale.b. Recognize Accounts Receivablei. Credit sales transfer products and services to a customer today whilebearing the risk of collecting payment from that customer in the future.ii. Even though the seller does not receive cash at the time of the credit sale, the firm records revenue immediately, as long as future collection from the customer is reasonably certain.iii. Along with the recognized revenue, at the time of sale the seller also obtains a legal right to receive cash from the buyer. The legal right to receive cash is valuable and represents an asset of the company.iv. Recording of Credit Sales1. Link’s Dental charges $500 for teeth whitening. Dee Kay decides to take advantage of the service, has her teeth whitened on March 1, but doesn’t pay cash at the time of These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.service. Dee promises to pay the $500 whitening fee to Link byMarch 31. Link’s Dental makes the following entry at the time of the whitening.v. Other types of receivables1. Nontrade receivables are receivables from those other than customers and include tax refund claims, interest receivable, and loans by the company to other entities including stockholders and employees. 2. When receivables are accompanied by formal credit arrangements made with written debt instruments (or notes), we refer to them as notes receivable. c. Calculate net revenues using discounts, returns, and allowancesi. Sales Discount1. Represents a reduction, not in the selling price of a product or service, but in the amount to be paid by a credit customer if payment is made within a specified period of time. 2. It’s a discount intended to provide incentive for quick payment.3. The amount of the discount and the time period within which it’s available usually are communicated in short-hand terms such as 2/10, n/30.a. The term “2/10,” indicates the customer will receive a 2% discount if the amount owed is paid within 10 days.b. The term “n/30,” means that if the customer does not take the discount, full payment is due within 30 days. ii. Trade Discounts1. Represent a reduction in the listed price of a product or service.2. Companies don’t recognize trade discounts directly when recording a transaction. Instead, they recognize trade discounts indirectly by recording the sale at the discounted price. 3. Let’s go back to Link’s Dental, which typically charges $500 for teeth whitening. Dr. Link offers a 20% discount on teeth whitening to any of his regular patients.iii. Sales Return and Allowances1. Sales Returna. If a customer returns a product it is sales return. After asales return, we reduce the customer’s accountbalance if the sale was on account or we issue a cash refund if the sale was for cash. 2. Sales Allowancesa. If a customer does not return a product, but the seller reduces the customer’s balance owed or provides at least a partial refund because of some deficiency in thecompany’s product or service, we call that a sales allowance3. Example: On March 5, after Dee gets her teeth cleaned but before she pays, she notices that another local dentist is offering the same procedure for $350. Dee brings this to Dr. Link’s attention and because his policy is to match any competitor’s pricing, he offers to reduce Dee’s account balance by $50.Link’s Dental records the following sales allowance entry.V. Valuation of Accounts Receivable a. Record an allowance for future uncollectible accountsi. The right to receive cash from a customer is a valuable resource for the company. This is why accounts receivable is an asset, reported in the company’s balance sheet.ii. To be useful to decision makers, accounts receivable should be reported at the amount of cash the firm expects to collect, an amountknown as net realizable value.iii. Allowance Method1. Involves allowing for the possibility that some accounts will be uncollectible at some point in future.2. Uncollectible accounts have the effect of:3. reducing assets (accounts receivable) by an estimate of the amount we don’t expect to collect and 4. increasing expenses (bad debt expense) to reflect the cost of offering credit to customers. iv. Estimating Uncollectible Accounts1. Consider an example. Kimzey Medical Clinic specializes in emergency outpatient care. Because it doesn’t verify the patient’s health insurance before administering care, Kimzey understands that a high proportion of fees for emergency care provided will not be collected. In 2012, Kimzey provides emergency care, billing customers $50 million. By the end of the year, $20 million remains due from customers but howmuch of this amount does Kimzey expect not to collect in the following year? 2. Let’s suppose that in previous years approximately 30% of accounts receivable were not collected; Kimzey decides to base this year’s estimate on that same percentage. Estimating uncollectible accounts based on the percentage-of-accounts receivable expected not to be collected is known as the percentage-of-receivables method.v. Bad Debt Expense1. Equals the amount of the adjustment to the allowance for uncollectible accounts, representing the cost of estimated future bad debts charged to the current period. We include this expense in the same income statement as the credit sales with which these uncollectible accounts are associated. 2. There is no cash outflow associated with bad debts.3. It is not possible to record actual future bad debts in the current period because we don’t know the future expense when preparing the current period’s financial statements. vi. Match Future Bad Debts with Current Credit Sales1. After we adjust for future uncollectible