Chapter 8: Receivables Learning Objectives: The methods used to estimate uncol
Houghton, Jaclyn, Oklahoma Reporter has reference to this Academic Journal, PHwiki organized this Journal Chapter 8: Receivables Learning Objectives: The methods used to estimate uncollectible accounts in addition to the net realizable value of accounts receivable. How firms estimate in addition to record sales returns in addition to allowances. How to evaluate whether or not receivables arose from real sales. Learning Objectives (contd.) How to impute in addition to record interest when notes receivable have either no implicit interest or unrealistic low interest rate. How companies use receivables to accelerate cash inflows in addition to how the accounting treatment affect the financial ratios. Securitization in addition to off-balance sheet financing. Receivables Current receivables-Collected within one operating cycle or one year, whichever is longer. Trade receivables: amount owed by customers as long as goods sold in addition to services rendered as part of normal business operations, including Accounts receivable: receivables arise from credit sales or per as long as ming services to customers on account.
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Receivables Trade Receivables (contd.): Notes receivable: receivables arise when the seller extends long-term credit to the buyer, who then signs a note. Nontrade Receivables: all others (i.e., interest receivable, advances to employees, deposits to cover potential damages, etc.) Accounts Receivable Accounts receivable are recorded at face amount to be collected. Management must periodically assess the allowance as long as uncollectibles. Management has to concern with: Recognition – when Valuation how Disposition collected/sell/write-offs Accounts Receivable : Recognition in addition to Valuation Recognition: Consistent with revenue recognition criteria. Valuation: Follow conservatism GAAP requires that accounts receivable be reported on the balance sheet at their net realizable value (NRV). NRV is to estimate value of Accounts Receivables to be ultimately collected by the firm.
Accounts receivable: Assessing NRV of Receivables Two amounts must be estimated to determine the NRV of receivables: Uncollectiblesthe amount that will not be collected because customers are unable to pay. Returns in addition to allowancesthe amount that will not be collected because customers return the merch in addition to ise or are allowed a reduction in the amount owed. NRV of receivables Gross amount owned Estimated uncollectibles Estimated returns & allowances = – – Uncollectible Accounts Describe the accounting treatment of anticipated uncollectible accounts receivable. Accounts Receivable: Why estimating uncollectibles is important Most companies establish credit policies by weighing the following: Expected cost (e.g. Customer collection in addition to billing costs plus potential bad debts) of credit sale. Benefit of increased sales. The bad debts are often unavoidable. The matching principle requires that the estimate of uncollectible accounts be offset against current period sales– Allowance Method Today Some future dates Time $10,000 current period sales $500 is uncollectible $500 estimated expense
Uncollectible Accounts Receivable Bad debts: the uncollectible accounts receivable. Methods to report receivables at the NRV: Direct Write-off Allowance method: Bad debt expense is recorded in the same accounting period in which the sales related to the uncollectible accounts were recorded. This method is in compliance with the matching principle. If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account). Direct Write-off Method Allowance Method Allowance Method: Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period.
Allowance as long as Uncollectible Accounts Net realizable value is the amount of the accounts receivable that the business expects to collect. Accounts Receivable Less: Allowance as long as Uncollectible Accounts Less: Returns in addition to allowances Net Realizable Value Uncollectible Accounts Allowance Method: Describe the two approaches to estimating bad debts Two Approaches to Estimate Bad Debts Allowance Method: Sales Revenues Approach (Percentage of Sales Method): Gross Receivables Approach Composite Rate (Percentage of Receivables): Aging of Receivables
Sales Revenues Approach Focuses on past credit sales to make estimate of bad debt expense. Emphasizes the matching principle by estimating the bad debt expense associated with the current periods credit sales. Bad debts expense is computed as follows: MusicL in addition to computes estimated Bad Debts Expense of $2,400. Sales Revenues Approach In 2006, MusicL in addition to has credit sales of $400,000 in addition to estimates that 0.6% of credit sales are uncollectible. What is Bad Debts Expense as long as 2006 Gross Receivables Approach Focuses on the collectability of accounts receivable to make the estimate of uncollectible accounts. Involves the direct computation of the desired balance in the allowance as long as uncollectible accounts. Two Estimation methods: 1. Composite Rate 2. Aging Receivable
Gross Receivables Approach 1. Composite Rate method: Desired balance in allowance as long as uncollectible accounts = year-end accounts receivable balance x bad debt expense % Desired balance in Allowance as long as Uncollectible Accounts Gross Receivables Approach : Composite Rate On Dec. 31, 2006, MusicL in addition to has $50,000 in Accounts Receivable in addition to a $200 credit balance in Allowance as long as Uncollectible Accounts. Past experience suggests that 5% of receivables are uncollectible. What is MusicL in addition to s Bad Debts Expense as long as 2006 Now, lets look at the accounts receivable aging approach!
Gross receivable approach: Estimated the uncollectibles by using Aging Schedule of Accounts Receivable An aging of receivables is simply a determination of how long each receivable has been on the books. Receivables that are long past due often because customers are experiencing financial difficulties in addition to may ultimately become uncollectible. The aging schedule generates the desire ending balance of Allowances as long as doubtful accounts . Aging Schedule of Accounts Receivable : Is the allowance as long as uncollectibles adequate DR Bad debts expense $11,750 CR Allowance as long as uncollectibles $11,750 The Allowance as long as uncollectible accounts has a balance of $39,000 prior to the adjustments. The allowance account needs to increase by $11,750. This is the difference between the desired balance ,$50,750, in addition to the existing balance $39,000. Accounts receivable disposition: Writing off bad debts Some time later, Bristol determines that a $750 receivable from Ralph Company cannot be collected. Note that no bad debt expense is recorded at this time because the estimated expense was previously recorded (matching principle). Allowance as long as uncollectibles $750 Accounts receivable Ralph Company $750 So what happens if someone pays after a write-off of the accounts receivable
Collection of Previously Written-Off Accounts When a customer makes a payment after an account has been written off, two journal entries are required. Accounts receivable: Underst in addition to ing receivable disclosures Scotts was taking a more conservative view of receivable collections in 2001. What impact did this conservative view have on the 2001 pre-tax earnings Sales Returns in addition to Allowances Describe the accounting treatment as long as merch in addition to ise returns
Sales Returns Merch in addition to ise returned by a customer to a supplier. Sales Allowances A reduction in the cost of defective merch in addition to ise. Sales Returns in addition to Allowances Sales Returns & Allowances (FASB 48) A. The amount of sales R&A is not significant Direct method B. The amount of sales R&A is significant in addition to six conditions are not met: Postpone the revenue recognition until all six conditions are met or the return period expired. Sales Returns & Allowances (FASB 48) C.The amount of sales R&A is significant in addition to six conditions are met: Allowance method.
Summary concluded Lenders often restructure loans when the customer is unable to make required payments. These troubled debt restructurings involve (a) settlement, or (b) continuation with modification of debt terms. Both the FASB in addition to the IASB have projects on financial instruments in addition to derecognition. 8-
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