financial accounting dave ludwick, p.eng, mba, pmp, phd chapter 10 receivables
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Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Chapter 10Receivables
In this chapter…Balance Sheet
Current Assets
Cash
Chapter
10000
Current Liabilities
Accounts Payable 5000
Accounts Receivable 10 20000 Wages Payable 25000
Notes Receivable 10 15000 Utilities Payable 2000
Marketable Securities 25000 Long-Term Debt
Inventory 120000 Notes Payable 20000
Capital Assets Bonds Payable 600000
Equipment 250000 Owner’s Equity
Buildings 500000 Common Stock 300000
Goodwill 60000 Retained Earnings
48000
Total Assets 1000000 Total Liabilities + OE 1000000
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Accounts Receivable• A receivable is an amount due from another party, the 2 most
common are:– Accounts Receivable – amounts due from customers for credit sales– Notes Receivable – amounts due from parties as a result of investment
• Accounts Receivable (AR) arises from credit sales to customers
Date Account Titles and explanation PR Debit Credit
Jul 3 Accounts Receivable 20000
Sales 20000
Jul 3 COGS 8000
Inventory 8000
July 15 Cash 20000
Accounts Receivable 20000
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Accounts Receivable Subledger• As is the case with AP, there is both an AR account in the
General Ledger as well as several AR subledger accounts for each customer– Subledger accounts are required so that the firm can keep track of
what is owned by individual customers
• Credit Sales can be created through the use of trade credit (sales on terms), or the use of credit cards– Credit Cards can be of 2 general types.
• Those issued by the firm itself (Sears, The Bay, Canadian Tire)
• Those issued by 3rd party credit card companies (Enroute, Discovery)
– Credit Cards issued by a 3rd party usually come with expenses that the firm must pay
• Transaction fee (a per transaction fee)
• Monthly fee for equipment rental
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Credit Card Sales Transactions• Initial credit card sale
• Cash received from CC Company
Date Account Titles and explanation PR Debit Credit
July 5 Accounts Receivable – CC Company 20000
Sales 20000
July 5 COGS 8000
Inventory 8000
Date Account Titles and explanation PR Debit Credit
July 25 Cash 19600
Credit Card Expenses 400
AR – CC Company 20000
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Valuing AR• Not all customers will pay their debts.
– Therefore companies need to make allowance for Bad Debt
– Why do companies sell on credit then? Well, like everything, the benefits of selling on credit (more impulse sales) out weigh the costs (a few customers who don’t pay)
• How do we account for Bad Debt– First, we need to estimate the amount we should expect (based on
historical patterns)• We must estimate because we will need to apply an expense caused
by bad debt in the current accounting period (remember, the matching principles says you need to match expenses in the same period as the revenues they helped to generate)
– Once we have an amount, we will create an AR “contra-account”
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Estimating Bad Debt• Two methods we can use
– Based on percentage of Sales
– Based on percentage of AR (as calculated as a % of AR or based on AR aging)
• AR aging refers to how old the outstanding invoice is (how long ago the sale was made)
– We’ll cover these calculation methods in more detail later
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Recording Estimated Bad Debt• As mentioned earlier, we will create a subledger account for
each customer who buys on credit
• We’ll also create an AR “contra-account” where we can store allowances for doubtful accounts. This contra-account is not named to any one customer as we do not know yet which customer will default on their credit– The Bad Debt expense account is just like any other expense account
– The “Allowance” account is the contra-account. It would be illustrated on the Balance Sheet as shown next…
Date Account Titles and explanation PR Debit Credit
Dec 31 Bad Debt Expense 200
Allowance for Doubtful Accts 200
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Recording Estimated Bad Debt• Notice how the AR account itself is untouched in the
previous journal entry– The T-accounts look like this
Accounts Receivable Sales Revenue
Dec 31 20000 20000 Dec 31
Bad Debt Expense Allowance for Doubtful Accts
Dec 31 200 200 Dec 31
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Allowance for Doubtful Accounts• The AFDA account is shown against the AR account
– This contra-account reduces AR to an amount expected to be collected
Balance Sheet
Current Assets
Cash 10000
Current Liabilities 32000
Accounts Receivable 20000
Less: Allowance for
Doubtful Accts
200 19800 Long Term Debt 620000
Other Assets 970000 Owner’s Equity 347800
Total Assets 999800 Total Liabilities + OE 999800
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Allowance for Doubtful Accounts• The Bad Debt Expense account is shown against the
Revenue for the period– The Bad Debt Expense account reduces the revenue by the same
amount that the contra-account reduces AR
Income Statement
Sales Revenue
Expenses
Bad Debt Expense
Net Income
20000
200
19800
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Writing off Bad Debt• So lets say our customer defaulted on the payment for a
credit sale:– We would write down a specific accounts receivable subledger
account
– This will write down the overall AR account in the GL
– And reduce the remaining Allowance for Doubtful Accounts
• The Balance Sheet now looks like…
Date Account Titles and explanation PR Debit Credit
Dec 31 Allowance for Doubtful Accts 20
AR – Dave Ludwick 20
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Writing off Bad Debt• After writing down the Dave Ludwick AR subledger account,
we notice that the Net AR account (AR less Allowance for Doubtful Accts) is not changed– That’s because we already allowed for the doubtful account
Balance Sheet
Current Assets
Cash 10000
Current Liabilities 32000
Accounts Receivable 19980
Less: Allowance for
Doubtful Accts
180 19800 Long Term Debt 620000
Other Assets 970000 Owner’s Equity 347800
Total Assets 999800 Total Liabilities + OE 999800
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Recovering Bad Debt• So we assumed a customer would not pay, so we wrote down his
account
• But now he has come back and paid, at least partly.
• The transactions are simply the reverse of the write down:– First, restore the Allowance and the AR subledger
– Then take the cash and run
Date Account Titles and explanation PR Debit Credit
Aug 31 AR – Dave Ludwick 20
Allowance for Doubtful Accts 20
Aug 31 Cash 20
AR – Dave Ludwick 20
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Estimating Bad Debt Expense• Earlier we said there were 2 ways to calculate Bad Debt
allowance– Based on percentage of Sales
– Based on percentage of AR
• Percent of Sales Approach– This approach applies a percent (based on historical experience) to
the total credit sales to estimate what is expected to be uncollectible
• So if last year you saw that 2% of credit sales remained uncollectible, unless you had info to indicate it would be different this year, you would apply a 2% factor the sales in the reporting period to estimate Bad Debt
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Estimating Bad Debt Expense• Percent of Accounts Receivable
– This approach implies that some portion of end of period AR balance is uncollectable
• A bad debt adjusting entry is made to bring the Allowance for Doubtful Accounts balance to the proportion of AR outstanding
• This requires an adjustment that considers the opening balance to the required outcome (We’ll see this by example in a minute)
• Aging Accounts Receivable– The older a receivable is, generally the less likely it will be collected.
– An Aging Analysis groups receivables by age (1-30 days, 30-60 days, 60+ days, as an example), then applies different %ages to different groups to estimate Bad Debt (see Exh 10.14)
• Again, we make the adjustment considering the opening balance and the required outcome (We’ll see this by example in a minute)
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Estimating Bad Debt Expense• Direct Write-Off Method
– This method does not use an advance estimate for Bad Debt Expense
– It only expenses Bad Debt as it happens
– So only once a credit sales has been determined as uncollectible does the AR subledger for that customer get written down.
– Like….
Date Account Titles and explanation PR Debit Credit
Aug 31 Bad Debt Expense 20
AR – Dave Ludwick 20
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Mid Chapter Demo Problem• Lets try the Mid Chapter Demo Problem
• Lets calculate the Bad Debt Expense and Allowance for Doubtful Accounts using – Estimate of total credit sales
– Estimate of outstanding AR
– Aging analysis
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Short Term Notes Receivable• Promissory Note: is a written promise to pay some amount
on demand or by some specific date– A Short-term Note Receivable is a promissory note due within the
business’s accounting period
– Usually a note is for non-operational receivables (like shareholder loans)
• Characteristics of a Note:– Principal – the amount owed to the business
– Interest – usually expressed as an annual interest rate
– Time – the amount of time to the required pay date
• Interest calculation– Interest = (Principal) x (Annual Interest rate) x (Time [years])
– As an example…
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Short Term Notes Receivable• Someone promises to pay for a $1000 purchase within 6
months (assuming a 12% interest rate)– Principal = 1000
– Annual Interest Rate = 12%
– Time [years] = 6/12 = .5
– Interest owed = (1000)x(.12)x(.5) = 60
• Ok, so what! Big deal! How do we use this in accounting
• Well, we make a loan and eventually receive payment of principal and interest. Here is what it looks like…..
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Short Term Notes Receivable• The loan…
• The payment…
Date Account Titles and explanation PR Debit Credit
June 5 Notes Receivable 1000
Cash 1000
Date Account Titles and explanation PR Debit Credit
Dec 5 Cash 1060
Notes Receivable 1000
Interest Revenue 60
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
End of Period Adjustment• If Notes are outstanding at the end of the period, but not
yet “collectable”, we need to make an entry to account for that portion of the interest earned during the period
• Then once payment is made in the new period:
Date Account Titles and explanation PR Debit Credit
Dec 31 Interest Receivable 30
Interest Revenue 30
Date Account Titles and explanation PR Debit Credit
Mar 31 Cash 1060
Interest Receivable 30
Interest Revenue 30
Notes Receivable 1000
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD
Sample Problems• Try the following
– Exercise 10-1
– Exercise 10-4
– Exercise 10-7
– Exercise 10-8
– Problem 10-4A
– Problem 10-10A
• Chapter 11
Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD