Chapter 7: Decision Analysis: Accounts Receivable Turnover

Accounts Receivable Turnover and its Role in Financial Analysis Accounts receivable turnover is a metric that reflects how efficiently a company collects receivables, indicating both the quality (likelihood of collection without loss) and liquidity (speed of collection) of its receivables. It shows how often, on average, accounts receivable are converted into cash within a period, helping assess financial stability. Formula for Accounts Receivable Turnover: Accounts Receivable Turnover=Net Credit Sales Average Accounts Receivable • Average Accounts Receivable: Calculated as (Beginning Balance+Ending Balance)/2 Example: • If TechCom has an accounts receivable turnover of 5.1, it implies that its average accounts receivable balance is collected and converted into cash 5.1 times over the period. Interpretation of Accounts Receivable Turnover: 1. High Turnover: Suggests efficient credit and collection practices, and the company may consider loosening credit terms to increase sales. 2. Low Turnover: Indicates possible issues with collections. Management may need to tighten credit policies or pursue overdue receivables more aggressively to reduce asset commitment in receivables. Practical Example with Visa and Mastercard: • Visa: With a turnover of 16.7, Visa converts its receivables into cash 16.7 times per year, reflecting effective receivables management. However, a slight decrease from the prior year's 17.6 suggests a need for review. Comprehensive Example: Journal Entries for Clayco Company 1. Write-off of Account Receivable: When Clayco writes off Briggs Company’s overdue $750 account under the allowance method: o Entry:  Debit Allowance for Doubtful Accounts $750  Credit Accounts Receivable - Briggs Company $750 2. Acceptance of a Note for Merchandise Sold: For a $1,000, 90-day, 10% note from Sumrell Company: o Entry:  Debit Notes Receivable $1,000 3. 4. 5. 6. 7. 8. Credit Sales $1,000 Sale with Cash and Note Payment Terms: When Clayco sells $12,000 in merchandise, receiving $2,000 cash and a $10,000, 120-day, 12% note from JT Co.: o Entry:  Debit Cash $2,000  Debit Notes Receivable $10,000  Credit Sales $12,000  Debit Cost of Goods Sold $8,000  Credit Merchandise Inventory $8,000 Credit Card Sale with Fee: For a $200 credit card sale with a 4% fee: o Entry:  Debit Cash $192 (net of 4% fee)  Debit Credit Card Expense $8  Credit Sales $200  Debit Cost of Goods Sold $150  Credit Merchandise Inventory $150 Dishonoring of Note Receivable: When Sumrell Company refuses to pay its note due October 28, the dishonored note plus accrued interest is charged to accounts receivable: o Calculate accrued interest for the 90-day, 10% note: Interest=1,000×0.10×90360=25 o Entry:  Debit Accounts Receivable - Sumrell Company $1,025  Credit Notes Receivable $1,000  Credit Interest Revenue $25 Additional Credit Card Sale with Fee: For a $500 credit card sale with a 5% fee: o Entry:  Debit Cash $475 (net of 5% fee)  Debit Credit Card Expense $25  Credit Sales $500  Debit Cost of Goods Sold $300  Credit Merchandise Inventory $300 Recovery of Written-Off Account: When Briggs Company pays its previously written-off $750 account: o Entry to Reinstate Receivable:  Debit Accounts Receivable - Briggs Company $750  Credit Allowance for Doubtful Accounts $750 o Entry to Record Cash Collection:  Debit Cash $750  Credit Accounts Receivable - Briggs Company $750 Receipt of Principal and Interest on Maturity: When JT pays the $10,000 note plus interest:  o o Calculate interest for the 120-day, 12% note: Interest=10,000×0.12×120360=400 Entry:  Debit Cash $10,400  Credit Notes Receivable $10,000  Credit Interest Revenue $400 Year-End Adjusting Entries for Bad Debts Estimation Situation A: Aging of Accounts Receivable Method • • If bad debts are estimated to be $20,400, and the unadjusted balance in Allowance for Doubtful Accounts is a $1,000 debit: Adjusting Entry: o Debit Bad Debts Expense $21,400 o Credit Allowance for Doubtful Accounts $21,400 Situation B: Percent of Sales Method • • If bad debts are 1% of $2,000,000 credit sales (or $20,000), with a $1,000 debit balance in Allowance for Doubtful Accounts: Adjusting Entry: o Debit Bad Debts Expense $21,000 o Credit Allowance for Doubtful Accounts $21,000