acc6ch09_2
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Establishing Internal Control
What are some controls over accounts receivable?
Separationof duties
Approval for write-off
Control overmail receipts
Use the allowance methodto account for uncollectibles
and estimate uncollectiblesby the percent of salesand aging approaches.
Objective 2
The Credit Department
Companies grant credit to customers in order to increase sales.
The credit department evaluates customers who apply for credit cards.
Percentage of Sales
This is also called the income statement approach.
It is based on prior experience of the business. It is computed as a percentage of credit sales. It ignores the current balance of the allowance
account. The percentage used is adjusted as needed to
reflect collection experience.
Percentage of Sales Example
The credit department of Ana’s Boutique estimates (based on prior experience) that 1% of net credit sales are uncollectible.
Net credit sales for the year just ended were $500,000.
What is the adjusting entry? $500,000 × 1% = $5,000
Percentage of Sales Example
Dec 31, 20xxUncollectible Account Expense 5,000
Allowance for Uncollectible Accounts 5,000
Recorded expense for the year
Decrease inNet Income
Decrease in netAccounts Receivable
What is the effect of this adjusting entry?
Percentage of Sales Example
Aging of Accounts Receivable
This approach is also called the balance sheet approach because it focuses on accounts receivable.
Individual accounts receivable from specific customers are analyzed according to the length of time they remain outstanding.
Aging of Receivables Example
Assume that International Hospital’s past collection experience indicates the following:
Length of time % uncollectible 1-30 days 2.0 31-60 days 3.0 61-90 days 5.0 90 + days 8.0
AccountsReceivable
Allowance forUncollectible Accounts
Length Amount %1-30 $1,900,000 2 $ 38,00031-60 1,000,000 3 30,00061-90 700,000 5 35,00090 + 500,000 8 40,000Total $4,100,000
$143,000
Aging of Receivables Example
Aging of Receivables Example
The allowance account is adjusted to this $143,000 balance:
Assume that the account currently has a credit balance of $100,000.
What is the adjustment?
Uncollectible Account Expense 43,000
Allowance for Uncollectible Accounts 43,000
To record allowance for uncollectibles
What if the account had adebit balance of $1,000?
Aging of Receivables
Comparing the Percentage of Sales and Aging Methods
Allowance Method
Percent of Sales Method Aging of Accounts Receivable Method
Adjusts Allowance forUncollectible Accounts
Adjusts Allowance forUncollectible Accounts
BY TO
UNCOLLECTIBLEACCOUNT EXPENSE
UNCOLLECTIBLEACCOUNTS RECEIVABLE
Amount of Amount of
Writing OffUncollectible Accounts What happens when it becomes apparent
that an account will not be collected? It must be written off. How? Debit Allowance for Uncollectible
Accounts. Credit Accounts Receivable.
Recoveries
How is the collection of a previously written- off account recorded?
Debit Accounts Receivable (to reinstate the account).
Credit Allowance for Uncollectible Accounts. Debit Cash. Credit Accounts Receivable (to record the
collection).
Direct Write-Off Method
Using this method, an account is written off only when it becomes uncollectible.
No allowance account is created. This method is simple to use. The balance sheet is overstated. The income statement is understated.
Credit Card and Bankcard Sales
These save retailers the cost of a credit department.
The retailer is required to pay a fee (called a discount) for usage.
Credit Card and Bankcard Sales
How would Ana’s Boutique record a $100 credit card sale with a 2% service charge?
Accounts Receivable (credit card) 98Credit Card Discount 2
Sales Revenue 100To record a credit card sale of $100less a 2% service charge fee
Notes Receivable: an Overview
A note receivable may arise from a sale or may be given in settlement of an account receivable.
The maker pays the payee the maturity value.
The maturity value includes principal plus interest.
Promissory Note $10,000.00 Nov. 30, 2004
For value received, I promise to pay to the order of
POPULAR BANK
HOUSTON, TEXAS
TEN THOUSAND AND NO/100…………DOLLARS
ON FEBRUARY 28, 2005
Plus interest at the annual rate of 10 percent.
__________Payee
Notes Receivable: an Overview
Promissory Note $10,000.00 Nov. 30, 20x4
For value received, I promise to pay to the order of
POPULAR BANK
HOUSTON, TEXAS
TEN THOUSAND AND NO/100…………DOLLARS
ON FEBRUARY 28, 20x5
Plus interest at the annual rate of 10 percent.
__________Principal
Notes Receivable: an Overview
Promissory Note $10,000.00 Nov. 30, 20x4
For value received, I promise to pay to the order of
POPULAR BANK
HOUSTON, TEXAS
TEN THOUSAND AND NO/100…………DOLLARS
ON FEBRUARY 28, 20x5
Plus interest at the annual rate of 10 percent.
__________
Date of issue
Notes Receivable: an Overview
Interest rate
Promissory Note $10,000.00 Nov. 30, 20x4
For value received, I promise to pay to the order of
POPULAR BANK
HOUSTON, TEXAS
TEN THOUSAND AND NO/100…………DOLLARS
ON FEBRUARY 28, 20x5
Plus interest at the annual rate of 10 percent.
__________
Notes Receivable: an Overview
Maturity date
Identifying a Note’sMaturity Date When the period is given in days…– the maturity date is determined by counting
the days from the date of issue. The date the note was issued is omitted. The maturity date is counted.
Principal × Rate × Time = Interest
$10,000 × 10% × 90 ÷ 360 = $250
Computing Interest on a Note
Compute interest on the note due to Popular Bank.Principal: $10,000Interest: 10%Time: December 1, 20x4, to February 28, 20x5
Recording Notes Receivable
Assume the accounting period ended December 31.
How much interest was earned by the bank as of December 31?
$10,000 × 10% × (31 ÷ 360) = $86.11
Recording Notes Receivable
December 31Interest Receivable 86.11
Interest Revenue 86.11To accrue interest on the note
Recording Notes Receivable
How does the bank record the collection at maturity?
February 28Cash 10,250.00
Note Receivable 10,000.00Interest Receivable 86.11Interest Revenue 163.89
Record interest on note
Dishonored Notes Receivable
If the maker of the note fails to pay the maturity value to the new payee, then the original payee legally must pay the bank the amount due.
Reporting Receivables
Some companies report a single amount for its current receivables in the body of the balance sheet.
They use a note to the financial statements to give more details.
Acid-test ratio = (Cash + Short-term investments+ Net current receivables) ÷ Total current liabilities
Acid-Test Ratio
This is a stringent test of liquidity. It measures the entity’s ability to pay its
current liabilities immediately.
Days’ Sales in Receivables
It is a measure of the time it takes to collect receivables.
A smaller number indicates a quick conversion to cash.
One day’s sales = Net sales ÷ 365 days
Days’ sales in average accounts receivable =Average net accounts receivable ÷ One day’s sales
Days’ Sales in Receivables