ACCOUNTS AND BUDGET SUPPORT LEVEL III

Learning
Unit of Competence Administrator Monitoring and Controlling
General and Subsidiary ledger

Lo1:- Reviewing Account Receivable Process

Information Sheet: 1Identify the Different Types of Receivables

 The term receivables refer to amounts due from individuals and companies.

 Receivables are claims that are expected to be collected in cash.

 Receivables represent one of a company’s most liquid assets.

 Receivables are frequently classified as:

 Accounts receivable:
 Are amounts owed by customers on account.
 Result from the sale of goods and services (often called trade receivables).
 Are expected to be collected within 30 to 60 days.
 Are usually the most significant type of claim held by a company.
 Notes receivable:
 Represent claims for which formal instruments of credit are issued as evidence of
debt.
 Are credit instruments that normally require payment of interest and extend for time
periods of 60-90 days or longer.
 May result from sale of goods and services (often called trade receivables).
 Other receivables:
 Nontrade receivables including interest receivable, loans to company officers,
advances to employees, and income taxes refundable.
  Generally classified and reported as separate items in the balance sheet.

Information Sheet: 1Explain how Accounts Receivable are Recognized in the

Accounts
Two accounting problems associated with accounts receivable are:
1. Recognizing accounts receivable
2. Valuing accounts receivable
Recognizing accounts receivable
 Service organizations -- A receivable is recorded when service is provided on account.
 Debit accounts receivable and credit service revenue
 Merchandisers – A receivable is recorded at the point of sale of merchandise on account.
 Debit accounts receivable and credit sales
 Receivable may be reduced by sales discount and/or sales return
Information Sheet: 3 - Describe the Methods Used to Account for Bad Debts
Valuing accounts receivable
 Determining the amount of accounts receivable to report is difficult because some receivables will
become uncollectible.
 This creates bad debt expense – a normal and necessary risk of doing business on credit.
Two methods are used in accounting for uncollectible accounts:
1. Direct Write-off Method
2. Allowance Method
 Direct Write-Off Method
 When a specific account is determined to be uncollectible, the loss is charged to Bad Debt Expense.
 For example, assume that Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on
December 12. The entry is:

Dec. 12 Bad Debts Expense 200

Accounts Receivable--M. E. Doran200
(To record write-off of M. E. Doran account)

 Bad debts expense will show only actual losses from uncollectibles.
 Bad debts expense is often recorded in a period different from that in which the revenue was recorded.

 Under this method, no attempt is made to:

(1) show accounts receivable in the balance sheet at the amount actually expected to be
received; and
(2) Match bad debts expenses to sales revenue in the income statement.

 Use of the direct write-off method can reduce the usefulness of both the income statement and balance
sheet.
 Unless bad debt losses are insignificant, the direct write-off method is not acceptable for financial
reporting purposes.
 Lo2:- Identifing Bad and Doubt ful debts
Information SheetAllowance Method
 The allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of
each period.
 It provides better matching of expenses and revenues on the income statement and ensures that
receivables are stated at their cash (net) realizable value on the balance sheet.
 Cash (net) realizable value is the net amount of cash expected to be received. It excludes amounts that
the company estimates it will not collect.
 Receivables are therefore reduced by estimated uncollectible amounts on the balance sheet through use
of the allowance method.
 The allowance method is required for financial reporting purposes when bad debts are material.
 Three essential features of the allowance method are:
1. Uncollectible accounts receivable are estimated and matched against revenues in the same
accounting period in which the revenues occurred.
2. Estimated uncollectibles are recorded as an increase to Bad Debts Expense and an increase to
Allowance for Doubtful Accounts (a contra asset account) through an adjusting entry at the end of
each period.
3. Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts
Receivable at the time the specific account is written off as uncollectible.
Recording Estimated Uncollectibles
 Allowance for Doubtful Accounts shows the estimated amount of claims on customers that are expected
to become uncollectible in the future.
 The credit balance in the allowance account will absorb the specific write-offs when they occur.
 Allowance for Doubtful Accounts is not closed at the end of the fiscal year.
 Bad Debts Expense is reported in the income statement as an operating expense (usually a selling
expense).
Recording the Write-Off
 Each write-off should be approved in writing by authorized management personnel.
 Under the allowance method, every bad debt write-off is debited to the allowance account (not to Bad
Debt Expense) and credited to the appropriate Account Receivable.
 A write-off affects only balance sheet accounts. Cash realizable value in the balance sheet, therefore,
remains the same.
Recovery of an Uncollectible

 When a customer pays after the account has been written off, two entries are required:
(1) The entry made in writing off the account is reversed to reinstate the customer’s account.
(2) The collection is journalized in the usual manner.
 The recovery of a bad debt, like the write-off of a bad debt, affects only balance sheet account.

In “real life,” companies must estimate the amount of expected uncollectible accounts if they use the
allowance method.
 Frequently the allowance is estimated as a percentage of the receivables.
 Management establishes a percentage relationship between the amount of receivables and expected
losses from uncollectible accounts.
 A schedule is prepared in which customer balances are classified by the length of time they have
been unpaid.
  Because of its emphasis on time, this schedule is often called an aging schedule and the analysis of
it is often called aging the accounts receivable.
 After the accounts are arranged by age, the expected bad debt losses are determined by applying
percentages, based on past experience, to the totals of each category.
 The estimated bad debts represent the existing customer claims expected to become uncollectible in
the future.
 This amount represents the required balance in Allowance for Doubtful Accounts at the balance
sheet date.
 Accordingly, the amount of the bad debts adjusting entry is the difference between the required
balance and the existing balance in the allowance account.
 Occasionally the allowance account will have a debit balance prior to adjustment because write-offs
during the year have exceeded previous provisions for bad debts.
 In such a case, the debit balance is added to the required balance when the adjusting entry is
made.

Information Sheet2 - Compute the Interest on Notes Receivable

 A promissory note is a written promise to pay a specified amount of money on demand or at a definite
time.
 In a promissory note, the party making the promise to pay is called the maker.
 The party to whom payment is to be made is called the payee. The payee may be specifically identified
by name or may be designated simply as the bearer of the note.
 Notes receivable
 give the holder a stronger legal claim to assets than accounts receivable.
 are frequently accepted from customers who need to extend the payment of an outstanding
account receivable, and they are often required from high-risk customers.
 notes receivable, like accounts receivable, can be readily sold to another party. Promissory
notes are negotiable instruments.
 There are three basic issues in accounting for notes receivable:
1. Recognizing notes receivable.
2. Valuing notes receivable.
3. Disposing of notes receivable.

Computing Interest

 The formula for computing interest is:

Face Value of Note (principle) x Annual Interest Rate x Time (in terms of one year)

 The interest rate specified on the note is an annual rate of interest. The time factor in the computation
expresses the fraction of a year that the note is outstanding.

When the maturity date is stated in days, the time factor is frequently the number of days divided by 360. For
example, the maturity date of a 60-day note dated July 17 is determined as follows:

Term of note 60 days

Days in July 31
Date of note 17
Note’s days in July 14
Days in August 31
 Plus note’s days in July 14
Notes days to the end of August 45 45
Maturity date, September 15

 When the due date is stated in terms of months, the time factor is the number of months divided by 12.

Lo3:- Reviewing Compliance and planning recovery action

Information Sheet:-Recognizing Notes Receivable

 To illustrate the basic entry for notes receivable, the text uses Brent Company’s $1,000, two-month, 8%
promissory note dated May 1. Assume that the note was written to settle an open account. The entry for the
receipt of the note by Wilma Company is as follows:

May 1 Notes Receivable 1,000

Accounts Receivable—Brent Company 1,000
(To record acceptance of Brent Company note)
 The note receivable is recorded at its face value, the value shown on the face of the note.
 No interest revenue is reported when the note is accepted because the revenue recognition principle does not
recognize revenue until earned. Interest is earned (accrued) as time passes.
 If a note is exchanged for cash, the entry is a debit to Notes Receivable and a credit to Cash in the amount of
the note.
Valuing Notes Receivable
 Like accounts receivable, short-term notes receivable are reported at their cash (net) realizable value.
 The notes receivable allowance account is Allowance for Doubtful Accounts.
 The computations and estimations are similar to the ones related to accounts receivable.
Information Sheet5 - Describe the Entries to Record the Disposition of Notes
Receivable
 Notes may be held to their maturity date, at which time the face value plus accrued interest is due.
 In some situations, the maker of the note defaults, and appropriate adjustment must be made.
 A note is honored when it is paid in full at maturity.
 A dishonored note is a note that is not paid in full at maturity.
 If the lender expects that it will eventually be able to collect, the Notes Receivable account is transferred to
an Account Receivable for both the face value of the note and the interest due.
 If there is no hope of collection, the face value of the note should be written off.

Information Sheet6 - Explain the Statement Presentation of Receivables

 Each of the major types of receivables should be identified in the balance sheet or in the notes to the
financial statements.
 Short-term receivables are reported in the current asset section of the balance sheet below short-term
investments. These assets are nearer to cash and are thus more liquid.
 Both the gross amount of receivables and the allowance for doubtful accounts should be reported.
 Notes receivable are listed before accounts receivable because notes are more easily converted to cash.
 Bad Debts Expense is reported under “Selling expenses” in the operating expense section of the income
statement.
  Interest Revenue is shown under “Other Revenues and Gains” in the nonoperating section of the income
statement.
 If a company has significant risk of uncollectible accounts or other problems with receivables, it is
required to discuss this possibility in the notes to the financial statements.
Information Sheet7 - Describe the Principles of Sound Accounts Receivable
Management
 Managing accounts receivable involves five steps:
1. Determine to whom to extend credit.
2. Establish a payment period.
3. Monitor collections.
4. Evaluate the receivables balance.
5. Accelerate cash receipts from receivables when necessary.
 Determine to whom to extend credit.
1. Risky customers might be required to provide letters of credit or bank guarantees.
2. Particularly risky customers might be required to pay cash on delivery.
3. Ask potential customers for references from banks and suppliers and check the references.
4. Periodically check financial health of continuing customers.
 Establish a payment period.
1. Determine a required payment period and communicate that policy to customers.
2. Make sure company's payment period is consistent with that of competitors.
 Monitor collections.
1. Prepare accounts receivable aging schedule at least monthly.
2. Pursue problem accounts with phone calls, letters, and legal action if necessary.
3. Make special arrangements for problem accounts.
4. If a company has significant concentrations of credit risk, it is required to discuss this risk in the notes to
its financial statements.
5. A concentration of credit risk is a threat of nonpayment from a single customer or class of customers
that could adversely affect the financial health of the company.
Information Sheet8 - Identify Ratios to Analyze a Company's Receivables
 Liquidity is measured by how quickly certain assets can be converted into cash. The ratio used to assess the
liquidity of the receivables is the receivables turnover ratio.

 The ratio measures the number of times, on average, receivables are collected during the period.

 The receivables turnover ratio is computed by dividing net credit sales (net sales less cash sales) by the
average net accounts receivables during the year.

 A popular variant of the receivables turnover ratio is to convert it into an average collection period in terms
of days. This is computed by dividing the receivables turnover ratio into 365 days.
 The general rule is that the average collection period should not greatly exceed the credit term period
(i.e., the time allowed for payment).

In some cases, receivables turnover may be misleading. Therefore, it is important to know how a company
manages its receivables.
Information Sheet9 - Describe Methods to Accelerate the Receipt of Cash from
Receivables
 Two common expressions apply to the collection of receivables:
1. Time is money—that is, waiting for the normal collection process costs money.
2. A bird in the hand is worth two in the bush—that is, getting the cash now is better than getting it later or
not at all.
 There are three reasons for the sale of receivables.
1. The size of the receivables may cause a company to sell them because it may not want to hold such a
large amount of receivables . In recent years, for competitive reasons, sellers (retailers, wholesalers, and
manufacturers) often have provided financing to purchasers of their goods. The purpose is to encourage
the sale of the company’s product by assuring financing to buyers.
2. Receivables may be sold because they may be the only reasonable source of cash.When credit is tight,
companies may not be able to borrow money in the usual credit markets or the cost of borrowing may be
prohibitive.
3. A final reason for selling receivables is that billing and collection are often time-consuming and
costly. As a result, it is often easier for a retailer to sell the receivables to another party that has
expertise in billing and collection matters.
National credit card sales:
 Approximately one billion credit cards are recently in use. A common type of credit card is a national credit
card such as Visa and MasterCard.
 Three parties are involved when national credit cards are used in making retail sales: (1) the credit card
issuer, who is independent of the retailer, (2) the retailer, and (3) the customer.
 A retailer’s acceptance of a national credit card is another form of selling—factoring—the receivable
by the retailer.
There are several advantages of credit cards for the retailer:
1. Issuer does credit investigation of customer.
2. Issuer maintains customer accounts.
3. Issuer undertakes collection process and absorbs any losses.
4. Retailer receives cash more quickly from credit card issuer.
 In exchange for these advantages, the retailer pays the credit card issuer a fee of 2% to 4% of the
invoice price for its services.
 Sales resulting from the use of national credit cards are considered cash sales by the retailer. Upon receipt
of credit card sales slips from a retailer, the bank that issued the card immediately adds the amount to the
seller’s bank balance.
 To illustrate, Morgan Marie purchases $1,000 of compact discs for her restaurant from Sondgeroth Music
Co., and she charges this amount on her Visa First Bank Card. The service fee that First Bank charges
Sondgeroth Music is 3 percent. The entry by Sondgeroth Music to record this transaction is:

Cash 970
Service Charge Expense 30
Sales 1,000
(To record Visa credit card sales)

Sale of receivables to a factor:

 A common way to accelerate receivables collection is a sale to a factor. A factor is a finance company or a
bank that buys receivables from businesses for a fee and then collects the payments directly from the
customers.
 Factoring arrangements vary widely, but typically the factor charges a commission of 1% to 3% of the
amount of receivables purchased.

Activity

Define receivables. What are the different types of receivables? Why is it necessary to have them in different
categories?

 Explain how accounts receivable are recognized in the accounts. How are accounts receivable valued on the
balance sheet?

 What are the two methods used to account for bad debts? Which method is required by GAAP if bad debts
are material? How is bad debt estimated when using the allowance method? Prepare journal entries for
each method. How is an aging schedule prepared? How is it used?

 What is a promissory note? What is the formula for computing interest on notes receivable? Discuss the
three issues involved in accounting for notes receivable. Prepare journal entries for note transactions.

 Describe the entries to record the disposition of notes receivable. Prepare the journal entries for a
dishonored note

 Explain the statement presentation of receivables

 Describe the principles of sound accounts receivable management. What are the five steps in managing
accounts receivable?
 What is the difference between general and subsidiary ledger.
 Identify and compute ratios to analyze a company's receivables. Explain what the ratios measure and what
they tell users of financial statements.
 What methods are used to accelerate the receipt of cash from receivables? Why do companies pay fees for
this service. Prepare journal entries for credit card sales.