Acct 230 1st Edition Lecture 16 Outline of Last Lecture I Cash a Accounts for Petty Cash b Major Inflows and Outflows of Cash c Earnings quality by comparing net income and cash flows Outline of Current Lecture II III Recognition of Accounts Receivable Valuation of Accounts Receivable Current Lecture IV Recognition of Accounts Receivable a Credit sales i Common for large business transactions in which buyers don t have sufficient cash available or where credit cards cannot be used because the 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 Receivable i Credit sales transfer products and services to a customer today while bearing 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 Sales 1 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 by March 31 Link s Dental makes the following entry at the time of the whitening v Other types of receivables 1 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 allowances i Sales Discount 1 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 Discounts 1 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 Allowances 1 Sales Return a If a customer returns a product it is sales return After a sales return we reduce the customer s account V balance if the sale was on account or we issue a cash refund if the sale was for cash 2 Sales Allowances a 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 the company s product or service we call that a sales allowance 3 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 Valuation of Accounts Receivable a Record an allowance for future uncollectible accounts i 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 amount known as net realizable value iii Allowance Method 1 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 Accounts 1 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 how much 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 Expense 1 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 Sales 1 After we adjust for future uncollectible accounts the accounts receivable portion of Kimzey s year end balance sheet appears below b Apply the procedure to write off accounts receivable as uncollectible i On February 23 2013