BUSA
101 – Fund. Of Acct I
Receivables
– Why are they important???
Receivables – (book’s definition) – monetary claims against other entities.
Receivables – (my definition) – SOMEONE OWES YOU
MONEY FOR SOMETHING
However you define it, a company’s receivables are
usually one of the largest current assets on a company’s books.
The control and analysis of this asset is VERY important, because
receivables are usually the biggest source of a company’s cash flow.
What happens when your cash flows don’t come in at home???????
You have trouble paying your bills and that leads to financial
hardship. Companies have the same
problem too. The proper control
over accounts receivables is VERY IMPORTANT.
The term “internal control” was introduced in the
previous chapters. We will
be dealing with internal control issues in each chapter as they are related to
the topic being discussed. See
separate handout for internal control considerations as they relate to
receivables.
Common
types of receivables:
Accounts Receivable – The most common kind of
receivable. It arises from sales
of services or merchandise on account. They
are usually due in 30 – 60 days. They
are classified on the Balance Sheet as a current asset.
Notes Receivable – Amounts that customers owe on
a formal, written, legal document. If
they are due within a year they are classified as current assets.
If the amounts are due after a year’s time, then they are classified
as long-term assets. Notes are
used for longer-term obligations, or as extra protection from customer’s
that may have some doubtfulness as to their creditworthiness.
Other Receivables – Any other types of receivables not mentioned above. Some types are income tax refunds that may be due, interest receivable, employee receivables, etc.
No matter how careful you are in extending credit,
a business always has some customers that will not pay their debts.
GAAP requires that you estimate this amount and record it in the same
year as the sale. (This insures
that we meet the requirements of the matching concept.)
We will talk more about this in a minute.
In order to help minimize the losses a company
experiences from uncollectible accounts, they need to be very careful and
prudent in extending credit.
References and credit scores should be checked and credit worthiness needs
to be established before credit is extended.
Once a receivable goes past due, companies need to put
forth great efforts to collect it. The
older a receivable gets, the less likely the chance of collection.
You will see this later when we look at the allowance method.
As previously mentioned, regardless of the care used in granting credit, there will always be those that don’t pay. The amount that we estimate to be uncollectible will be debited to a new operating expense called Uncollectible Accounts Expense (aka bad debts expense or doubtful accounts expense….they are used interchangeably.) and credited to Allowance for Doubtful Accounts. This account (Allowance…) is a contra asset. It will offset the Accounts Receivable Balance. The presentation of Accounts Receivable on the Balance Sheet will be similar to this:
Accounts Receivable 100,000
Allowance for Doubtful Accounts (1,000) 99,000
The 99,000 shown above is called the “net realizable
value” and estimates what the company can realistically expect to realize
from the collection of their account receivables.
GAAP mandates that we use the Allowance Method of estimating uncollectibles. (The Direct Write Off method is used by some smaller companies, because it is needed for tax purposes, however it is NOT GAPP.) Most companies estimate their uncollectibles under the allowance method using one of two approaches:
The allowance is determined based on an analysis of aged receivables
OR
The allowance is determined based on a percentage of sales
The method chosen will determine the calculation.
We will practice this extensively in class, however in a nutshell, this
is how it works:
Allowance based on the analysis of ALL aged
receivables: The first step
is to age the receivables into categories of how old they are. Each account
that is over a specific number of days past due is scrutinized and considered
for write off purposes. The next
step is to apply historical or industry % of uncollectibility to all the
totals of the various aging categories. When
the amounts of estimated uncollectibles are added up, it will result in the
amount that the Allowance account SHOULD BE.
Based on the current balance in the allowance account, an adjustment is
made for the DIFFERENCE…for whatever it takes to get the allowance up
to the amount calculated based on the aging.
This method results in the most accurate calculation because 100% of
the receivables are reviewed. On
the flip side, however, it is more time consuming and requires many judgements
as to collectibility.
Allowance based on a % of sales:
Under this method, the amount of the adjustment is very easy to
calculate, however based on the fact that only the current years sales amounts
are used, it is not as accurate as looking at 100% of the receivables.
Under this method, the accountant takes the current years sales and
multiplies it by a historical rate of uncollectibility.
This results in the amount of the journal entry.
Note that under this method this number is ADDED to the existing
allowance account to arrive at the total in the allowance.
(As opposed to the other method where the existing balance is
considered in arriving at the amount of the adjustment.)
No matter which method is used, the allowance account
will track both the estimated amounts to be written off, as well as the
accounts that actually do go bad and are written off.
A T-account may help you analyze how this account works.
We will go over this in class.
Actual Write Offs:
Strict internal control procedures should be used when writing off an account that is no longer deemed collectible. We will discuss these in class. When an account is deemed uncollectible, the journal entry to write it off is as follows:
Dr. Allowance for Doubtful Accounts
Cr. Accounts Receivable.
Notice how an expense account is NOT USED in the write
off process. This is because the
expense account was recorded in the year of the sale…in other words we
reserved in advance for the possibility of the account going bad. To debit an expense account would be to “double do”
it again. This is why the
allowance method is required by GAAP; because we attempt to match the expense
with the related revenue in the same year!
This chapter will be challenging because 100% of the
material is brand new. Therefore,
make certain that you devote the proper amount of time to the course material.
This chapter also covers the basic entries needed for Notes Receivable. In this chapter, notes are usually generated when a traditional A/R goes bad. A note is requested which explicitly cites the terms of repayment, including interest. The three common note transactions that you will be expected to know are:
You will also need to be able to calculate a note’s due date, the interest amount due, and the resulting maturity value.