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Statement Presentation and Analysis

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LEARNING OBJECTIVE 9 Explain the statement presentation and analysis of receivables.

Companies should identify in the balance sheet or in the notes to the financial statements each of the major types of receivables. Short-term receivables appear in the current assets section of the balance sheet. Short-term investments appear before short-term receivables because these investments are more liquid (nearer to cash). Companies report both the gross amount of receivables and the allowance for doubtful accounts. In a multiple-step income statement, companies report bad debt expense and service charge expense as selling expenses in the operating expenses section. Interest revenue appears under “Other revenues and gains” in the nonoperating activities section of the income statement.

Analysis Investors and corporate managers compute financial ratios to evaluate the liquidity of a company's accounts receivable. They use the accounts receivable turnover ratio to assess the liquidity of the receivables. This ratio measures the number of times, on average, the company collects accounts receivable during the period. It is computed by dividing net credit sales (net sales less cash sales) by the average net accounts receivable during the year. Unless seasonal factors are significant, average net accounts receivable outstanding can be computed from the beginning and ending balances of net accounts receivable. For example, in 2009 Cisco Systems had net sales of $32,420 million for the year. It had a beginning accounts receivable (net) balance of $3,177 million and an ending accounts receivable (net) balance of $4,929 million. Assuming that Cisco's sales were all on credit, its accounts receivable turnover ratio is computed as follows.

Illustration 8-17 Accounts receivable turnover ratio and computation

The result indicates an accounts receivable turnover ratio of 8 times per year. The higher the turnover ratio, the more liquid the company's receivables. A variant of the accounts receivable turnover ratio that makes the liquidity even more evident is its conversion into an average collection period in terms of days. This is done by dividing the turnover ratio into 365 days. For example, Cisco's turnover of 8 times is divided into 365 days, as shown in Illustration 8-18, to obtain approximately 46 days. This means that it takes Cisco 46 days to collect its accounts receivable.

Illustration 8-18 Average collection period for receivables formula and computation

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Companies frequently use the average collection period to assess the effectiveness of a company's credit and collection policies. The general rule is that the collection period should not greatly exceed the credit term period (that is, the time allowed for payment).

DO IT! Analysis of Receivables In 2014, Phil Mickelson Company has net credit sales of $923,795 for the year. It had a beginning accounts receivable (net) balance of $38,275 and an ending accounts receivable (net) balance of $35,988. Compute Phil Mickelson Company's (a) accounts receivable turnover and (b) average collection period in days.

Action Plan ✓ Review the formula to compute the accounts receivable turnover. ✓ Make sure that both the beginning and ending accounts receivable balances are considered in the

computation. ✓ Review the formula to compute the average collection period in days.

Solution (a)

(b)

Related exercise material: BE8-12, E8-14, and 8-4.

Copyright © 2012 John Wiley & Sons, Inc. All rights reserved.

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DO IT! 8-4 Compute ratios for receivables. (LO 9)

In 2014, Lauren Company has net credit sales of $1,480,000 for the year. It had a beginning accounts receivable (net) balance of $112,000 and an ending accounts receivable (net) balance of $108,000. Compute Lauren Company's (a) accounts receivable turnover and (b) average collection period in days.

Copyright © 2012 John Wiley & Sons, Inc. All rights reserved.

Page 1 of 1Chapter 8. Accounting for Receivables

7/28/2014http://edugen.wiley.com/edugen/courses/crs6417/weygandt9780470929384/c08/weygandt...