Chapter+9+Notes+-+Receivables

Homework: SS1; BE9-1, BE9-2; E9-1 Highlights:
 * __SO 1 - 2 - Different types of receivables__**

- **receivables** refer to monies owing from individuals and businesses

- **accounts receivable** refer to credit instruments representing monies owing from debtor customers to creditor suppliers following purchase of goods or services on account - accounts receivable represent informal promises to pay another - payment generally due within 30 days - interest or financing or penalty charges __may__ attach to past due (late) accounts, often between 18 - 24% per annum (1.5 - 2% per month)

- **notes receivable** (covered in detail later in this chapter) refers to formal, written credit instruments (legal contracts such as IOUs or promissory notes) representing monies owing from individuals and businesses with or without interest, often the result of past due account receivable that has been converted into formal note to ensure prompt payment - notes are typically due within 30-90 days or more - notes receivable may either be listed as current assets or long-term assets on the balance sheet depending upon their due date

- accounts receivables and notes receivables that result from ordinary sales transactions are referred to collectively as **trade receivables**

- **non-trade receivables** include accruals of interest earned on investments, recoverable sales taxes and income taxes, and loans to company executives and employees

- ordinary **sales on account** (under **periodic inventory system**) typically involve the following transactions (ignoring sales taxes) concerning the initial sale, return of goods and eventual receipt of payment:

**Revenue - cr - 100 (+)**
 * (a) Accounts Receivable - dr - 100**

- **Accounts Receivable - cr - 20 (+)**
 * (b) Sales Returns and Allowances - dr - 20**

**Accounts Receivable - cr - 80**
 * (c) Cash - dr - 80**


 * + = second entry at cost prices necessary under perpetual inventory system**

- please note that when debtors do not pay their bills in full by the end of the month, some retailers may add a financing (interest) charge on the amount outstanding -> this amount must be recognized in the books of the retailer as follows:

- **Interest Revenue - cr - 166.67** To record accrual of 20% interest owing after one month on outstanding debt of $10,000 (10,000 x 20% x 1/12)
 * Interest Receivable - dr - 166.67**

Homework: SS2, SS3, SS4, SS5; BE9-3, BE9-4, BE9-5, BE9-6; E9-3 Highlights:
 * __SO 3 - Valuing receivables and estimating uncollectibles__**


 * - accounts receivable,** a current asset, must be valued accurately on both the income statement and balance sheet at end of period in recognition of the fact that some outstanding accounts will __likely__ become __uncollectible__ the longer they remain past due

- **two methods exist for recognizing uncollectible accounts receivable:**


 * (i) direct write-off method** and
 * (ii) allowance method**


 * (i) direct write-off method:** under **direct write-off method**, loss is charged (debited) to **Bad Debts Expense** (normal operating expense also known as Uncollectible or Doubtful Accounts Expense) and credited __directly__ to **Accounts Receivable** only when account is ultimately determined by management to be uncollectible or unrecoverable, e.g., following death of debtor - unfortunately direct write-off method does not always match expenses to revenues in the same period (a violation of the Matching Principle) or reflect true (realizable) value of Accounts Receivable at end of each period and so this method is __not__ acceptable under GAAP or IFRS

-- **Accounts Receivable - cr -1000** To record write off of $1000 outstanding account receivable determined to be uncollectible under direct write-off method
 * Bad Debts Expense - dr - 1000**


 * (ii) allowance method ** : under more realistic ** allowance method, ** attempt is made to __ estimate __ uncollectible accounts receivable at the end of each period via an ** adjusting entry **, thereby determining ** net realizable value ** (amount ultimately expected to be received from debtor customers in cash - see below) of accounts receivable

(1) **step one** in allowance method is **calculating** and **recording end-of-period estimated losses (bad debts) from uncollectible accounts** using either **percentage of sales basis** or **percentage of receivables basis**, each of which leads to end-of-period **adjusting entry** requiring debit to **Bad Debts Expense** (see above) and credit to **Allowance for Doubtful Accounts** (contra asset account with credit balance, also known as Allowance for Bad Debts or Allowance for Uncollectibles, found just below Accounts Receivable on balance sheet, so that **Accounts Receivable minus Allowance for Doubtful Accounts = net realizable value of accounts receivable**)

(a) **percentage of sales basis** employs fixed percentage of **net credit sales** (sales on account minus sales returns and allowances) for the period as determined by management based on past experience - **due to income statement emphasis of percentage of sales basis, existing end-of-period balance in Allowance for Doubtful Accounts is __disregarded__ in this calculation** - please note that IFRS does __not__ encourage use of this method in calculating uncollectible accounts receivables

(b) **percentage of receivables basis** employs either

(i) simple **fixed percentage of total receivables** **method** or (ii) more complicated **varying percentage of aged receivables** **method** -> **schedule of aged receivables on page 429** represents all unpaid accounts receivable classified by number of days outstanding, and percentage of aged receivables basis assumes the longer a receivable is past due, the more likely it will __not__ be collected, i.e., higher percentage estimates of uncollectibles are attached to older receivables

- please note that calculation using fixed percentage of total receivables or varying percentage of aged receivables will only result in **required balance** in ADA

- **due to balance sheet emphasis of percentage of receivables basis, existing end-of-period balance in Allowance for Doubtful Accounts __must be taken into account__ in calculation** -> therefore, amount of bad debt adjusting entry is calculated as the difference between required balance determined by percentage calculation and __prior existing balance__ in ADA contra account -> and please note that a __debit__ balance in ADA will complicate this calculation even further (see 1bii below)

(2) **step two** in allowance method is recording potential **write-off (elimination) of uncollectible accounts** determined by management to be permanently unrecoverable, e.g., following death of debtor - under allowance method, write-off is debited to Allowance for Doubtful Accounts and credited to Accounts Receivable - net result is no change in **net realizable value** of accounts receivable as both asset account (Accounts Receivable) and contra account (Allowance for Doubtful Accounts) decrease by same amount due to write off - note that bad debts expense is __not__ involved in write-off

(3) **step three** in allowance method is recording potential **recovery of previously written-off uncollectible account** - unexpected receipt of payment from debtor customer following write-off requires two entries: (i) reversing entry of previously recorded write-off (Accounts Receivable debit, Allowance for Doubtful Accounts credit) and (ii) customary entry to record receipt of payment from debtor customer (Cash debit, Accounts Receivable credit) - net result is reduction in net realizable value of accounts receivable as contra account (Allowance for Doubtful Accounts) increases while asset account (Accounts Receivable) remains constant

__**Exercise**__ ** (T) **

(1a) **adjusting entry re:** **estimated losses for uncollectible accounts receivables** at end of period calculated at 1% of net credit sales of $100,000 (or $1,000) under **percentage of sales basis**

-- **Allowance for Doubtful Accounts - cr - 1000**
 * Bad Debts Expense - dr - 1000**

- or -

(1bi) **adjusting entry re:** **estimated losses for uncollectible accounts** **receivables** at end of period calculated at 3% of accounts receivable of $100,000 ($3,000) **assuming existing Allowance for Doubtful Accounts __credit__ balance of $1000** under **percentage of receivables basis**

-- **Allowance for Doubtful Accounts - cr - 2000**
 * Bad Debts Expense - dr - 2000**

(1bii) **adjusting entry re:** **estimated losses for uncollectible accounts** **receivables** at end of period calculated at 3% of accounts receivable of $100,000 ($3,000) **assuming existing Allowance for Doubtful Accounts __debit__ balance of $1000** under **percentage of receivables basis**

-- **Allowance for Doubtful Accounts - cr - 4000**
 * Bad Debts Expense - dr - 4000**

(2) **write off of $100 account receivable** determined by management to be permanently unrecoverable

- **Accounts Receivable - cr - 100**
 * Allowance for Doubtful Accounts - dr - 100**

(3) **recovery of previously written-off $100 account receivable**

(i) **Accounts Receivable - dr - 100**
 * -- Allowance for Doubtful Accounts - cr - 100**

(ii) **Cash - dr - 100** -- **Accounts Receivable - cr - 100**


 * Click below for a pdf summary of valuing accounts receivable at the end of each period:**



Homework: SS7; BE9-7 Highlights: retailers occasionally dispose of (sell) their accounts receivables to other firms (known as **factors**) at discounted prices who then assume responsibility for collection of all outstanding debts and absorb any losses stemming from delinquent debtors - this process is known as **factoring** - factors will often advance between 90 to 98% of the net realizable value (representing a 2 to 10% factoring or discount fee) of all outstanding receivables, but most factors will also charge additional administrative fees for their services - factoring companies may or may not be protected against potential losses from non-collection of assumed debts given the terms of their agreement with retailers
 * __SO 4 - Credit card and debit card sales__**

- **credit cardsales** are a form of factoring as retailers (e.g., The Gap) who permit credit card payments from consumer purchasers will accept less than 100% of the sale price from card issuers (e.g., Visa, American Express) in exchange for advance payment from said card issuers who then assume responsibility for collection of outstanding debts from cardholders (consumer purchasers) - difference between original sale price and funds advanced by card issuer to retailer is known as **merchant discount** or **swipe fee** or **service fee** (see below) - retailers who accept credit cards as payment may benefit from increased sales and quicker receipts of funds, while simultaneously avoiding the obligation to maintain customer accounts or investigate credit histories of consumers

- as stated above, **credit cards issued by banks** (such as **Visa** and **MasterCard**) carry a negotiated **merchant discount** or **swipe fee** or **service fee** (journalized as **Credit Card Expense** in the books) for this service, generally 1 to 3% of the sale price, and such transactions are considered **cash sales** from the retailer's perspective as payment is almost immediately forthcoming from the card- issuing banks


 * $100 Visa credit card sale in books of retailer (assuming 2% service fee)**

-- **Sales - cr - 100**
 * Cash - dr - 98**
 * Credit Card Expense - dr - 2**

- **credit cards that are __not__ issued by banks** (such as **American Express, Discover** and **major department stores** who in essence, issue their own cards) also carry a negotiated **merchant discount** or **swipe fee** or **service fee** (again journalized as **Credit Card Expense** in the books) for this service, generally 1 to 5% of the sale price, and such transactions are considered **sales on account** (and __not__ cash sales) from the retailer's perspective as payment is __not__ immediately forthcoming from the card issuer


 * $100 American Express credit card sale in books of retailer (assuming 4% service fee)**

-- **Sales - cr - 100**
 * Accounts Receivable (AmEx) - dr - 96**
 * Credit Card Expense - dr - 4**

- **credit card** **service** **fees** are usually divided among the retailer's bank, the credit card issuer's bank (e.g., TD, RBC) and the credit card network itself (e.g., VISA, MasterCard)

- **debit cards** issued by banks carry a negotiated **Interac service fee** (journalized as **Debit Card Expense** in the books) for this service, generally 1 to 5% of the sale price, and/or a **per transaction fee** (e.g., 50 cents per transaction), and such transactions are considered __cash__ sales from the retailer's perspective as payment is immediately transferred by the bank from the purchaser's bank account to the retailer's bank account


 * $100 debit card sale in books of retailer (assuming 3% service fee)**

**Sales - cr - 100**
 * Cash - dr - 97**
 * Debit Card Expense - dr - 3**

Homework: SS8, SS9; BE9-8, BE9-9 Highlights: **promissory notes** or **IOUs** are formal written promises to pay a specified amount of money (principal) either on demand (at the request of the holder) or at a specified future date (often 30 days or more) with or without interest to a designated payee
 * __SO 5 - 7 - Notes receivable (begin reading on page 434)__**

- promissory notes may be issued

(i) when companies lend monies to others (ii) when companies sell on account where the dollar value or credit period of the sales transaction exceeds ordinary limits (iii) in settlement of past due (late) accounts receivables when the debtor customer agrees to sign a note in recognition of his/her outstanding debt obligation

- the party promising to make payment is called the **payor** or **maker** or **issuer** of the note, while the party to whom payment is due is called the **payee** or **holder** or **bearer** of the note

- promissory notes are journalized as **Notes Receivable** in the books of the payee

- promissory notes (like most cheques) are considered **negotiable instruments,** i.e., formal written documents containing the signature of the payor/maker/issuer that promise payment, either upon demand or at a specified future date, to a designated payee/holder/bearer

- furthermore, the payee/holder of a negotiable instrument can always assign or transfer (i.e., sell) the debt obligation to another party via **endorsement** (e.g., signature on back of note)

- like accounts receivable and estimating uncollectibles, notes receivable are calculated and listed at their **net realizable value** (**Notes Receivable minus Allowance for Doubtful Notes**) on the balance sheet following an end-of-period adjusting entry recognizing **Bad Notes Expense**

- **notes issued in settlement of past due accounts receivable** are recorded at their principal or face value (amount outstanding), while interest is only recorded as it accrues over time (Interest Receivable dr, Interest Revenue cr) or is eventually collected (Cash dr, Interest Revenue cr)


 * $1000 past due account receivable converted to promissory note**

-- **Accounts Receivable - cr - 1000**
 * Notes Receivable - dr - 1000**

__**SO 8 - 9 - Receipt of notes receivable and past-due notes**__ Homework: BE9-10, BE9-11; E9-9 Highlights:

- note is **honoured** when it is paid/collected in full on or before the maturity (due) date - for interest-bearing note, amount due on maturity is principal (original amount borrowed or provided on credit) plus interest (cost of borrowing or credit) accrued/accumulated over length of time note is outstanding (term)
 * __Honoured notes__**


 * Collection of $1000 promissory note on date of maturity at 8% interest over six-month term (assuming interest due at maturity)**

-- **Notes Receivable - cr - 1000** -- **Interest Revenue - cr - 40**
 * Cash - dr - 1040**

- remember that interest rates are always expressed as __annual__ interest rates, i.e., for a 12-month period

- note is **dishonoured** when it is __not__ paid/collected in full at maturity, i.e., when payment is late
 * __Dishonoured notes__**

- dishonoured note is no longer transferable/assignable (capable of being sold to third party) but payee/bearer/holder of note (creditor) maintains personal claim against payor/maker/issuer of note (debtor)

- **dishonoured note i****s typically converted to accounts receivable** because note, by definition, must be a negotiable instrument capable of transfer (see above), but that said, journal entry to record dishonouring of note ultimately depends upon whether or not note is __reasonably expected to be collected__ in the future


 * (i) Dishonouring of $1000 promissory note on date of maturity plus $40 interest accrued __where collection is still expected__**

- in cases where collection is ultimately expected, note must be converted to ordinary accounts receivable and interest revenue __is__ recorded given that payment of both principal and interest is anticipated

- **Notes Receivable - cr - 1000** - **Interest Revenue - cr- 40**
 * Accounts Receivable - dr - 1040**


 * (ii) Dishonouring of $1000 promissory note on date of maturity plus $40 interest accrued __where collection is not expected__**

- in cases where collection is not expected, note must be "written off" in same manner as uncollectible accounts receivable above and interest revenue is __not__ recorded as payment of neither principal nor interest is anticipated

-- **Notes Receivable - cr - 1000**
 * Allowance for Doubtful Notes - dr - 1000**

- as negotiable instruments, outstanding **notes receivable** may always be sold off (or **discounted**) at discounted prices to interested third parties who then assume responsibility for collection of debt, not unlike the **factoring of accounts receivable**

- receivables (accounts and notes) typically appear as current assets on balance sheet below cash and cash equivalents (or temporary investments) - net realizable value of receivables (A/R - ADA; N/R - ADN) appears in balance sheet with gross figures and allowances listed in accompanying notes to financial statements - Bad Debts Expense, Debit Card Expense and Credit Card Expense appear on income statement as selling expenses in operating expenses section - Interest Revenue appears on income statement under other revenues and gains in non-operating section
 * __Listing of receivables__**

Homework: SS10; BE9-12 Highlights: collection of **trade receivables** (**accounts and notes receivables**) has significant impact on company's **solvency (ability to pay one's debts as they become due)**
 * __SO 10 - Solvency and liquidity ratios__**

- four ratios assist in measurement of firm's **solvency** and **short-term liquidity (ability to convert assets into cash):**


 * 1) current ratio = current assets / current liabilities**

e.g., $200 / $100 = 2:1


 * 2) quick ratio (acid-test ratio) = cash and cash equivalents (marketable securities/short-term investments) + net receivables / current liabilities**

e.g., $60 / $100 = 0.6:1


 * 3) annual receivables turnover = annual net credit sales / average accounts receivable during year (beginning a/r + ending a/r / 2)**

e.g., $5000 / ($400 + $600 / 2) = $5000 / $500 = 10 times / year


 * 4) average collection period = 365 days / annual receivables turnover**

e.g., 365 days / 10 times = 36.5 days