Accounting for Receivables

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CHAPTER
8
ACCOUNTING FOR RECEIVABLES Wed, Nov 26 will be
Unit 3 Test (covering chapter 7 and 8)
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Subsidiary AR Ledger

• Since Adorable Garment has many companies (and
  individuals) as customer, they would like to keep
  track of each customers AR.
• Most companies use a subsidiary ledger to keep
  track of individual customer accounts.
• Each entry which affects AR is posted twice
  once to the subsidiary ledger and once to the
  general ledger. (manual system)
• In computerized accounting you just have to post
  once to the subsidiary ledger.

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Subsidiary AR Ledger

• Normally entries to the subsidiary ledger are
  posted daily while entries to the general ledger
  are summarized and posted monthly.
• For example, the previous transaction was posted
  to subsidiary ledger called, AR Zellers on
  July 1.
• On July 31, this transaction will be combined
  with other sales entries of the month (6000
  3000 1000 10000) in a special sales journal
  and posted to the accounts receivable control
  account in the general ledger at the end of the
  month.

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Subsidiary AR Ledger

• Show Illustration 8-1 on the board (P410)
• Collections (collecting money from customers) on
  account were also posted individually to the
  subsidiary ledger accounts.
• Non-recurring entries such as the sales return of
  100 are posted to both the subsidiary and
  general ledgers individually.
• Note that the balance of 4000 in the control
  account agrees with the total of the balances in
  the individual accounts receivable accounts in
  the subsidiary ledger. (2000 2000 0 4000)

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Interest Revenue

• If the customer does not pay their AR debt in 30
  days, then the business can charge interest
  revenue.
• The interest rate depends on the negotiations
  that buyer and seller made while negotiating the
  terms.
• If Kids Online Store still owes 2000 on August
  31, then the business will charge 30 (2000
  0.18 1/12)
• August 31 AR Kids Online 30
• Interest Revenue 30
• To record interest on amount due
• Interest Revenue is included in other revenues in
  the non-operating section of the Income Statement
  because this companys business operation is
  manufacturing.

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Nonbank Credit Card Sales

• In Chapter 7, we learned that debit and bank
  credit card sales are cash sales.
• Store credit card sales (such as Canadian Tire
  credit card and Sears credit card) are not cash
  sales. (debit AR until the credit card company
  pays the amount)

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Nonbank Credit Card Sales

• Example Suppose Long M Music accepts a nonbank
  credit card ( store credit card) on October 24
  for 500 sale.
• Oct 24 AR Credit card company 480
• Credit Card expense (4) 20
• Sales 500
• 20 0.04 500
• Credit card expense and debit card expenses are
  reported as an operating expense in the income
  statement.

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Valuing AR

• Some receivables ends up becoming uncollectible.
  ( customer will not be able to pay his or her
  debtgoing bankrupt)
• Only collectible receivables can be reported as
  assets in the financial statements.
• This collectible amount is called the net
  realizable value of the receivables.

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VALUING ACCOUNTS
RECEIVABLE

• To ensure that receivables are not overstated on
  the balance sheet, they are stated at their net
  realizable value.
• Net realizable value is the net amount expected
  to be received in cash and excludes amounts that
  the company estimates it will not be able to
  collect.
• NRV AR Bad debt (uncollectible AR)

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Valuing AR

• No matter how reliable (in terms of paying their
  AR on time) the customer has been in the past,
  some AR becomes uncollectible.
• When receivables are written down to their net
  realizable value because of credit losses,
  owners equity must also be reduced. (by debiting
  bad debt expense account)

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Valuing AR

• The key issue is when do you record these
  uncollectible AR (credit losses)?
• If the company waits until it knows for sure that
  the specific account will not be collected, then
  it could end up recording the bad debt expense in
  a different period than when the revenue is
  recorded.
• Violating which GAAP principle?

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VALUING ACCOUNTS RECEIVABLE

• Two methods of accounting for uncollectible
  accounts are
• 
  1. Allowance method
• (honors matching principle)
• 
  2. 2.Direct write-off method

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DIRECT WRITE-OFF METHOD

• Under the direct write-off method, no entries are
  made for bad debts until an account is determined
  to be uncollectible at which time the loss is
  charged to Bad Debts Expense.
• No attempt is made to match bad debts to sales
  revenues or to show the net realizable value of
  accounts receivable on the balance sheet.
• Is allowed by IFRS and US IRS (but US GAAP does
  not allow)

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THE ALLOWANCE METHOD

• The allowance method is required when bad debts
  are deemed to be material in amount.
• Uncollectible amounts are estimated (before the
  it is deemed uncollectible) and the expense for
  the uncollectible accounts is matched against
  sales in the same accounting period in which the
  sales occurred.
• It honors matching principle
• IFRS and US GAAP allows this method.
• But US IRS (Tax agency) does not allow this
  method.

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THE ALLOWANCE METHOD
Estimated uncollectible amounts are debited to
Bad Debts Expense and credited to Allowance for
Doubtful Accounts (a contra asset account of AR
account) at the end of each period.
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BASES USED FOR THE ALLOWANCE METHOD

• Companies use either of two methods in the
  estimation of uncollectible accounts
• 1. Percentage of sales
• 2. Percentage of receivables
• Both bases are GAAP the choice is a management
  decision.

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PERCENTAGE OF SALES BASIS

• In the percentage of sales approach, you
  calculate bad debts expense as a percentage of
  net credit sales.
• Management decides the percentage based on past
  experience and the companys credit policy.
• Lets say Calvin Klein uses this method. The
  management decides 2 of net credit sales will
  become uncollectible.
• Net credit sales for 2013 is 1.2 million .
• The estimated bad debt expense is 24,000 (2
  1,200,000)

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PERCENTAGE OF SALES BASIS

• In the percentage of sales approach, you
  calculate bad debts expense as a percentage of
  net credit sales.
• Management decides the percentage based on past
  experience and the companys credit policy.
• Lets say Calvin Klein uses this method. The
  management decides 2 of net credit sales will
  become uncollectible.
• Net credit sales for 2013 is 1.2 million .
• The estimated bad debt expense is 24,000 (2
  1,200,000)

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PERCENTAGE OF SALES BASIS

• Dec 31 Bad debt Expense 24000
• Allowance for DA 24000
• To record estimate of bad debt expense
• Allowance for DA
• 1000 (Dec 31 Beg bal)
• 24000 (Dec 31 Adj entry)
• 25000 (ending balance)

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PERCENTAGE OF SALES BASIS

• We ignored the beginning balance of the Allowance
  for DA.
• If the beginning balance was 20,000 (instead of
  1000) for example, then they should use lower
  percentage such as 1 in 2013.
• If the actual write off in the next year is very
  different from the estimated amount, then a
  different percentage should be used in
  calculating the bad debt expense.
• This approach results in excellent matching of
  expenses with revenue because bad debt expense is
  related to the sales recorded in the same period.
  

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PERCENTAGE OF SALES BASIS

• This method is easier than percentage of
  receivables approach.
• Some people call this one as income statement
  approach.

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Classwork / Homework

• P434 be8-4,
• P436 e8-2, e8-3, e8-4 (sales basis)