 Hello and welcome to the session in which we would look at account receivable, but first we're gonna look at receivables in general Then we will dive into accounts receivable in particular. This topic is covered in intermediate accounting course and Surely this topic is covered on the CPA exam Receivable is a major topic on the exam whether you are dealing with allowance for doubtful account Sales returns and discounts sales allowances You have to know receivable inside out factoring receivable and we're gonna cover all these topics in the recordings So what I would suggest is what whether you are an accounting student or a CPA candidate to strongly? Take a look at my website farhat lectures calm if you're studying for your CPA exam I don't replace your CPA review course. I'm a useful addition to your CPA review course. 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Your potential gain is passing the exam If not for anything take a look at my website to find out how well or not well your university doing on the CPA exam This is a catalog of all my accounting courses advanced accounting intermediate managerial auditing governmental My supplemental CPA review courses are aligned with your becker Wiley Roger Gleam so on and so forth so it's very easy to go back and forth and I do have all the previously AI CPA released questions Almost 1,500 Questions with detailed solution So I strongly suggest you take a look at my website if you have not connected with me on LinkedIn Please do so take a look at my LinkedIn recommend it like LinkedIn recommendation like this recording share it with other connect with me On Instagram Facebook Twitter and Reddit So what are receivables what are receivables in general with their claims against others you are expecting to be paid Something from others usually we're gonna be dealing with customers But the point I want to illustrate in the first slide is receivable could be claimed against other people Usually it doesn't have to be only customers. It could be a claim against the government Acclaim against someone that you lent money to so it doesn't have to be receivables But we're gonna be dealing with receivables mainly claim against others for money Goods or services so either they have to pay you back the money They have to provide you goods or they have to provide you some service Receivables could be current or non-current in this session We're gonna be focusing solely on account receivable. Therefore, we're gonna be dealing with current receivables We could have receivable that are non-current as well and we can break our receivables into two types we have trade and Obviously if it's straight, it's gonna be non trade the second one under trade receivable We have accounts receivable and we have notes receivable now Why do we call them trade and specifically we're gonna be focusing on this? Session here accounts receivable in a separate recording. We have to focus on notes receivable It's as important as accounts receivable. So those two They they come about as a result of selling goods and services or lending money as part of your operation Therefore, they are part of your trade now We could also have non-trade receivables, which is we don't really cover in depth But there's not much to them like if you have a tax refund claims You file you had a dispute with the government or you filed your return and you're waiting for a refund That refund is a receivable. You're waiting to be paid your back taxes. Guess what? Well, you're paid waiting to be paid It's receivable. It's not a trade receivable. It's a non-trade receivable. You could have interest in dividend You earned some interest at the bank, but they have not paid you yet. You have some dividend coming You did not receive them yet. Those are non-trade receivable advanced to employees You gave your employees you advanced them some money. Guess what? You're gonna deduct them from their salaries That's receivable for you if you have a subsidiaries Well, you lend them money when they pay you back. It's not really a receivable. It's basically alone advanced is basically alone to a Subsidiary. It's not part of your operation. It's to help the other company, which is most likely It's related to you if it's subsidiaries also You could have receivable such as deposit paid as guarantee of performance Sometimes you pay money to to guarantee a performance then they give you that money back It's gonna come back to you or payment to cover potential damages the same concept So you could have trade and non-trade our focus is straight specifically Our focus is a counter receivable and a counter receivable is always almost current It means you want to be paid within within 30 days or within 60 days or within 90 days It's always less than a year a Counter-receivable recognition. How does it work? It works when we sell something on credit for example Adam sold Merchandise on credit to Ryan sold a transformer worth a hundred dollars. So Ryan will debit account receivable For a hundred times Adam would debit account receivable for a hundred and will credit sales revenue for a hundred, okay? So what happened is this we what happened here? We have a sales transaction Okay, and this is how a count receivable comes to life. It comes to life So this is the first step in the life of a receivable Well, Adam sold something Adam has the right for the payment. There's a revenue process here Adam passes the title gave that transformer to Ryan or they gave them the actual transformer here Here they're giving them the actual transformer, you know, it's a small toy Adam no longer has any significant risk and reward in the ownership They fully transfer it and Ryan has accepted the transformer therefore what happened here if we have we have a sale So the account receivable comes about from a revenue recognition perspective once we recognize the revenue There is an account receivable. Okay, so it arises as part of the revenue arrangement It's when you satisfy your performance Obligation whatever the performance obligation happens to be you transfer the goods and the services now It's very important to understand how account receivable is initially recorded. What's the initial valuation? Well, we have to look at the consideration received. What are we expecting to receive in consideration in compensation for that? Okay, so consideration expected to be received to be received Which is the transaction price from the customer in exchange for those goods and services. What do you expect to receive in return? Okay, now there are variable consideration that goes into that initial valuation. What are some variable consideration? We could have trade discounts. We could have sales or cash discount We could have sales returns and allowances. We could have the time value of money factor So we have to take those variable consideration into account We're gonna discuss each one of them separately using examples when necessary to illustrate the point But simply put a count receivable comes to life as a result of a sale usually not usually a count receivable as a result of a sale And I showed you Adam sold a transformer to Ryan. We have an account receivable first a straight discount What is a trade discount? You have to understand what it is. It's a volume or quantity discount For example, if we have an item a regular plot the regular price of one unit is a hundred dollar Okay, then the company says a few purchase one thousand unit will give you a discount of 20% So notice usually it's a hundred dollar in the catalog, but they tell you By one thousand will give you a 20% discount now when you when the company sells The let's assume they sold a batch of 1000 it means they sold each unit for 80 dollars You would record you would record the sale at the discount price of 80 dollars So simply put you would ignore the trade discount not much to it the trade discounters not much to it simply put trade discount Is ignored we we sold something for 80 dollars Although we said the list price is 100. We gave you a trade discount. You ignore all of that. How much did we sell it for? We sold it for 80 dollars. So that's the first thing we have to discuss is a trade discount. It's pretty much nothing It's basically a non case You just want to you just want to be aware if you're taking your exam or the CPA exam to ignore the trade discount You know, we don't take it into account We don't say that we had the item in the catalog for a hundred dollar then when we sold it we sold it for 80 So we're gonna record it first at 100 and discounted to 80. We don't just we sold it at 80 This is what we record the second issue. We have to deal with is Sales or cash discount. That's two or four. What is a discount? What is a cash discount or sales discount? Basically a discount It means a reduction in price is giving to incentivize to encourage customers to pay early Why because we want the cash we want to pay our employees we want to pay our Suppliers we want to operate the business we need that cash So one way to incentivize them will tell them look will give you some sort of a discount For example, the scouts are listed something like this to slash 10 and 30. It means here's here's what it means. It means You have 30 days to pay. Okay. This is called the credit period 30 days is the credit period. Okay, you have 30 days to pay credit I'm gonna call this credit period Then if you pay within 10 days 10 days, this is day 10 We're gonna give you 2% off. This is called the discount period So we'll give you 2% off if you pay within 10 days within the discount period none Nothing is giving and the amount is due in 30 days. So that is a variable consideration It's gonna what's gonna happen is it's gonna affect how much is your account receivable or sales at the end of the day Okay, let's take a look at an example on June 3rd Arab company sold to Ryan company merchandise for 3000 they gave them to slash 10 and 60 they gave them 60 days to pay However, if you if you pay within 10 days will give you 2% off the bill So we're gonna prepare the journal entries using what we call both the gross method and the net method What's the difference between the gross method and the net method? The gross method is we record the whole 3000 initially and we wait until to see what's gonna happen with the discount under the net method We record the transaction initially at the net amount We assume that the customer will take the discount and at the end of the day It doesn't make a difference the net but what we have to know both. So let's start in with the gross method We sold something for 3000 debit account receivable Credit sales and we Ryan now owes us $3,000 Now Ryan's gonna pay within the discount period Ryan pays us on June 12th, which is before Before June 13th 10 days within that Ryan will only have to pay 2960 why because if we take 3000 times 0.980 Ryan's gonna pay only 98% of his bill Because we gave them 2% off or you can take 3000 times 2% is $60 and he's gonna pay us $60 less than 3000 So we would remove Ryan's account for the full 3000 notice we credit account receivable for 3000 Simply put account receivable is gone We debit cash 2960 and we debit sales discount. You have to understand sales discount as a contra Revenue account it has a debit balance. It's it's a debit balance. It's a contra revenue It's listed on the income statement as a reduction in revenue. This is the gross method Now let's take a look at the net method under the net method We assume that Ryan will take the discount Therefore, we would record the transaction as a count receivable from Ryan 2940 sales revenue 2940 we assume that's gonna happen if that happened indeed great We debit cash 2940 credit account receivable Ryan 2940 account receivable is simply gone All what we have is debit sales debit cash credit sales revenue. So what happened? If Ryan does not take advantage of the discount. Well, if that's the case We're gonna have we're gonna have something called sales discounts for fitted and it looks something like this So if Ryan does not pay by June 13th, they paid July 29th. They'll have to pay us three thousand. Okay, we'll take it The we would remove his account at 29 2940 because we assume the net method therefore we have to remove the account at 2940 and the difference is $60 It's called sales discount for fitted basically sales discount for fitted is like other revenue Okay, we kind of we thought we're gonna only receive 2940. We end up receiving three thousand that extra $60 is basically Other revenue now. Why is it important to keep track of this amount sales discount for fitted because you want to see if your customers are Taking advantage of your discount if they're not you want to kind of say what should I do? Should I increase my discount from two to three percent? Should I move the period to 30 to 30 days? Should I defer it to 90 days? What's going on if that might give you some Indication of what's happening with your sales discount But definitely sales or cash discounts is a variable consideration because it does make a difference of how much you would receive at the end Of the day the third item that we have to be concerned about when it comes to a Contraceable is something called sales returns and allowances. What is sales returns and allowances basically sales return? We should all be familiar with that concept is when we have the right to return the merchandise due to the wrong color wrong size We're not happy with it. It's defective. Whatever the reason is we return the merchandise sales allowance is a little bit different They you could have received the wrong product or the wrong size or the wrong color. You would call the Shipper and the seller and tell them look. I'm not happy with this. They would say, okay, keep it if you keep it Don't return it will give you a price reduction will give you what they called a credit So this is called the sales allowance. So they would reduce your account receivable They would reduce your bill will give you a credit. Okay, how do we have to account for that sales return and allowances? Well, let's look at an example During 20 x 5 Adam company sold 2 million worth of merchandise The cost of merchandise was 60% of the selling price based on past experience Adam believe 10% of sales will be returned Okay, so first let's take a look the selling is for 2 million 2 million worth of merchandise the cost of sale is 60 percent 60 percent of 2 million is 1.2 million Let's stop right here and record the sale. Well, we debit cash. Let's assume we receive cash 2 million Credit sales revenue 2 million debit cost of goods sold 1.2 credit inventory 1.2 the 1.2 coming 60% of the sale is cost. So 60% of 2 million is 1.2 million. So that's cost of goods sold Okay, now based on past experience Adam believe 10% will be returned in 20 x 5 customer returned actually 150,000 worth of merchandise So when Adam makes a sale it's 2 million Times 10% Adam believe 200,000 will be returned Based on past experience 10% of our sales are returned and usually Usually customers knows what's the return rate based on their experience from several years They would know for every million dollars 2% or 1% return or 3 or 4 or whatever that percentages now Now the company can book the can book the 2 million now Or they can wait till the end of the year to book the 2 million to book the 200,000 because what's gonna happen between now? This is during 20 x 5 so they can wait till the end to see what happened But they know based on these sales there should be 200,000 dollar return Well during the year during 20 x 5 customer returned customer returned 150,000 worth of merchandise well we debit sales merge sales return, which is a contra Revenue just like sales discount contra revenue with reducing our sales therefore on the income statement. We're gonna have sales minus sales discount Minus sales Return when I say discounts discount plus usually there plus allowance, but those are contra revenues They reduce your sales to get to net Sales they're reducing your sales also since they returned the merchandise We will put back the merchandise and inventory and we're gonna assume the inventory still in good shape They're worth 60% of the sales 60% of 150,000 is 90,000 so we debit inventory and reduce our cost by 90,000 because the we no longer We no longer can book the sale. Therefore the related cost has to be reduced. So this is the sales return Okay, now if this if it was a sales allowance We don't well the sales allowance works when you have a receivable, okay Because you would reduce their bill now if you want to do a sales allowance You'll have to give them back their money. You'll have to write them a check for example if this was a sales allowance Let's assume you told the customer look. We know you're not happy with 150,000 But we're gonna give you $10,000 back. Well, guess what? We don't need this entry Okay, so what we do is we debit sales returns and allowances 10,000 Credit cash and we'll give them the money will send them a check for 10,000 or a wire check better They could they should wait ha ha now not they should wait But from the time value perspective you want to Increase the time from a cash management perspective For the customer to receive the money. So this is the This is the entry but here we're dealing with the sales return now remember our initial estimate was 200,000 and So far during the year customer return 150,000 it means we still have 50,000 that could be potentially be returned but not now It's the end of the year now. So what do we do at the end of the year? We prepare an adjusting entry. So this is end of period whatever that period is the end of the year We debit sales return again because we need to have sales return in total for that year of 200,000 which we just did We credit refund liability. We say guess what and Down the road, we're gonna have to pay an additional 50,000 to our customers. So we create a liability Then we debit an inventory estimated return account, which is an asset. It's like an inventory account But it's not listed with inventory. This is the amount we anticipate to receive back from Customers. So it's not we don't put it part. It is inventory estimated return It is an asset, but it's listed Separately separately. So it's a different asset. It's a different asset because you want to know how much you are expected to receive in return That's an important number that this way you could also have a control over your inventory better control over your inventory And you credit and you reduce cost of goods sold Now when the customer comes back and they actually return the 30,000 worth of merchandise, we're gonna We're gonna We're gonna debit. This should be 50,000. Sorry, this is 50,000 50,000 Inventory is 30 and 30. Okay. So when they returned when they actually return the inventory, we're gonna issue them a check for 50,000 we're gonna debit refund liability. Therefore, the refund liability is gone And we're gonna credit cash because we're gonna give them a cash of 50,000 Now we're gonna put the inventory back on the books. The inventory for us is 30,000. Therefore, we debit inventory 30,000 and we remove this estimated return now this remember this I told you the estimated return is a form of inventory But now that inventory is gone now it becomes actual inventory because they did actually return the goods So this is how it works with sales returns and allowances. Remember refund liability is obviously a liability sales return is counter revenue Inventory estimated return is an asset specifically inventory inventory it anticipated to be returned However, it's listed separately and the last item we deal with is time value of money Which is the four of the four consideration Remember account receivable is a future payment. So in the future, you're gonna be receiving some money You are standing here today. And what did we learn in the prior chapter when we when we talked about the time value of money? Every time you are receiving money in the future or paying money in the future You have to discount it you have to find the present value of that and guess what the account receivable is something You're gonna be receiving into the future Therefore from a theoretical perspective future receipt at payment should be recorded at the present value Okay, so if the company expect to receive a thousand dollar three month from now It should record this amount that it's present value. You have to discount it. It has to be less Maybe it's worth 985 dollars depending on what interest rate you used or 980 dollars and the difference is interest right the difference between the thousand and the discounted amount is interest now From a practical perspective from a materiality perspective companies ignore this interest component for account receivable it's not material and the assumption is since it's arising from the operating of the business it should not be called interest You should not account for this separate amount as interest revenue Because interest is basically it's a non operating business if you're selling If you're selling appliances and you're generating some interest, that's not what you do You're selling appliances. Therefore the interest should not be part of your core business Okay, so companies ignore this interest component from a materiality and because it's rising in the normal course of business Simply put just like trade discount You can ignore the time value of money when it comes to receivable So trade discount time value of money. They're not really issues But since from a theoretical perspective, you have to look at them and I hope time value of money here gave you a Different perspective about time value of money because if you're receiving a thousand if you discount the difference The difference will be interest revenue. Okay, but we don't account for it interest revenue We just ignore it now when it comes to notes, it's gonna be totally different when it comes to notes We'll look at that when we cover the notes receivable component at the end of this recording I'm gonna remind you again whether you are an accounting student or a CPA candidate to take a look at my material far hat lectures calm I don't replace your CPA review course. I'm a useful addition I can help you understand the material better Which in turn will help you do better on the exam add those 10 to 15 points to secure a passing grade Along your CPA review course. I cannot do it by myself Good luck study hard. The CPA is worth it invest in yourself