Chapter 9 ACC 358

Bad Debt expenses

are losses from uncollectable accounts recorded as an other impairment loss in the income statement

allowance for uncollectable accounts

is a estimated amount of receivables the company is not expected to be able to collect

-Increased by bad debt

- decreased by write offs

Sales Revenue Approach(income statement approach)

estimate as part of current period sales, used when sales are level

Gross Receivables Approach( balance sheet approach)

estimate as percentage of gross sales receivables

used when sales are seasonal or fluctuate

Relationship between debt expense, the allowance for bad debts and accounts receivables written off

increase bad debt expense, I increase allowance then if i write off receivable i decrease the allowance

what is the net realizable value of accounts receivables

-amount we expect to actually collect

-Gross receivable- what we estimate is uncollectable

-what we need to estimate: credit losses and returns and allowances

why is net realizable value of accounts important

avoid overstating assets, matches bad deb to period it occurs in and provide info for investors

what is ageing of accounts receivables

categorizing invoices by length of time they have been outstanding

-each bracket is given a estimated %

-loss % increases w time

why is aging of accounts used

to assess the reasonableness of our allowance estimate and show how that estimate can change over time

-it updates loss % over time

-checks whether prior estimates are still accurate given current conditions

how is ageing of accounts used

multiply the balance in each aging bracket by its historical loss rate

how to evaluate whether or not reported receivables arose from real sales

-growth rates in accounts receivables should roughly equal to sales

Danger Signals

increases in accounts receivables relative to sales frequency can be a sign of a problem.

Reasons for the growth

-loosening of sales terms to attract new customers

-determining credit worthiness among existing customers

-changed revenue recognition policy

what is imputed interest

the process of allocating the proceeds of a note between sales revenue and interest income

why must companies impute and record interest when notes receivables have no explicit or unrealistically lower interest rate

done to separate sales revenue from interest income

prevailing rate

normal rate on the market

stated rate

what rate we charge (legally binding contract rate)

if there is no rate

PV of the note payment =cash selling price

if rate is unrealistically low

you apply the prevailing interest rate and ignore the stated rate

summary rule

no stated rate: solve for the discount rate that balances the PV to cash price

Below market stated rate: use the prevailing market rate for similar credit risk

Explain how to account for accounts and notes receivable using the fair value option and why this option might be used

Fair value option: the option to record notes receivables at fair value instead of NRV,

why: reflect the realistic current value of those receivables on the balance sheet, providing a more accurate picture of a company's financial health than historical cost

Sales of receivables (factoring)

companies sell their receivables to a third party (Factor) to get immediate cash(Control has been surrendered, transferer has no obligation to repurchase)

- receivables removed from balance sheet

-gain or loss recognized in earnings

Effects of factoring ratios: improves ROA and Deb to equity

Collateralized borrowing

borrow money and pledge our accounts receivables as collateral (Control has NOT been surrendered, transferer has obligation to repurchase)

-receivables stay on balance sheet

-loans shown as balance sheet liability

- no gain or loss recognized in earnings

Effects: raises debt to equity ratio

Troubled debt restructuring, why it occurs,

Troubled Debt: If the borrower is unable to pay off the original debt and the lender (creditor) has granted a concession.

Criteria if either are met…

-modifies the terms of the loan

-accepts cash, other assets, or equity interest that is less than -the value of the debt.

why a lender is willing to do a settlement

Settlement: Cancel the original loan by a transfer of cash or other asset, or equity interest in borrower’s stock to the lender.

The lender often recovers more through a restructuring or settlement than through foreclosure or forcing bankruptcy.

why is a lender willing to do restructuring

Continuation with modification of debt term by canceling the original loan and signing a new loan agreement