CHAPTER 9ACCOUNTING FOR RECEIVABLES
CHAPTER 9ACCOUNTING FOR RECEIVABLES
CHAPTER 9ACCOUNTING FOR RECEIVABLES
STUDY OBJECTIVESAfter studying this chapter, you should understand:
Types of receivables
Disposition
of A/R
Valuation
of N/R
Recognition of A/R
Maturity & Interest of N/R
Disposition of N/R
Valuation
of A/R
Recognition
of N/R
F/S Presentation & Analysis
STUDY OBJECTIVE 1
TYPES OF RECEIVABLESSTUDY OBJECTIVE 1
TYPES OF RECEIVABLES
Receivables are amounts due from individuals and other companies.There are three major classes of receivables:
A/R N/R OtherOwed by customers
on account, from credit sales, due in
30-60 days.
Claims supported by a formal credit instrument. Due in 60-90 days, with
interest.
Loans to company officers, employee
advances, refundable income taxes.
PRIMARY ACCOUNTING ISSUESPRIMARY ACCOUNTING ISSUES
Recognition
Valuation
Disposition
STUDY OBJECTIVE 2
RECOGNIZING A/RSTUDY OBJECTIVE 2
RECOGNIZING A/R
Date Description Debit Credit
July 1 A/R—Polo Company 1000
Sales 1000
(sales on account)
July 5 Sales returns & allowances 100
A/R—Polo Company 100
(merchandise returned)
July 11 Cash 882
Sales Discounts 18
A/R—Polo Company 900
(collection of A/R)
A classic general journal sequence for credit sales.
• Receivables are current assets on the balance sheet• They are stated at net realizable value, the amount
expected to be received in cash. • Uncollectible A/R are accounted for using two methods
STUDY OBJECTIVE 3
VALUATION OF A/RSTUDY OBJECTIVE 3
VALUATION OF A/R
Direct Write-OffMethod
AllowanceMethod
• No entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to bad debts expense.
• Bad debt expense shows only actual losses.• Not acceptable for financial reporting purposes
unless losses are insignificant.
DIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHOD
Bad debts expense
Operating expenseon the
income statement
Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. When this method is used, Bad Debts Expense
will show only actual losses from uncollectibles.
Date Account Titles Debit Credit
General Journal
Dec. 12 Bad Debts Expense 200 Accounts Receivable – M.E. Doran 200
DIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHOD
• The allowance method is required when bad debts are material.
• Uncollectible accounts are estimated
• The expense is matched against sales in the same accounting period.
ALLOWANCE METHODALLOWANCE METHOD
Uncollectible accounts expense = bad debts expense
Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful
Accounts at the end of each period.
Date Account Titles Debit Credit
General Journal
Dec. 31 Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000
ALLOWANCE METHODRECORDING ESTIMATED UNCOLLECTIBLES
ALLOWANCE METHODRECORDING ESTIMATED UNCOLLECTIBLES
Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable
at the time the specific account is written off.
Date Account Titles Debit Credit
General Journal
Mar. 1 Allowance for Doubtful Accounts 500
Accounts Receivable - R. A. Ware 500
ALLOWANCE METHODRECORDING A WRITE-OFF
ALLOWANCE METHODRECORDING A WRITE-OFF
To recover an account that has been written off:
1 reverse the write-off entry.
Date Account Titles Debit Credit
General Journal
July 1 Accounts Receivable – R. A. Ware 500 Allowance for Doubtful Accounts 500
ALLOWANCE METHODRECORDING A RECOVERY
ALLOWANCE METHODRECORDING A RECOVERY
Date Account Titles Debit Credit
General Journal
July 1 Cash 500 Accounts Receivable 500
2 record the collection in the usual manner.
Percentage of Sales Percentage of Receivables
Emphasis on Income Statement Relationships
Emphasis on Balance Sheet Relationships
ALLOWANCE METHODBASIS FOR ESTIMATING UNCOLLECTIBLES
ALLOWANCE METHODBASIS FOR ESTIMATING UNCOLLECTIBLES
Two methods of estimating uncollectible accounts comply with GAAP.
Uses aging schedule
• Bad debt expense is based on a % of current credit sales estimated to be uncollectible, based on past experience.
• Matches expenses with revenues.
• No consideration given to existing balance in the allowance.
ALLOWANCE METHODPERECENTAGE OF SALES BASIS
ALLOWANCE METHODPERECENTAGE OF SALES BASIS
Date Account Titles Debit Credit
General Journal
Dec. 1 Bad Debts Expense 8,000
Allowance for Doubtful Accounts 8,000
If net credit sales for the year are $800,000, the estimated
bad debts expense is $8,000 (1% X $800,000).
• Bad debt expense based on % of the ending balance in A/R. • The adjusting entry is the difference between the required
balance and the existing balance in the allowance account.• Estimates NRV of receivables.
ALLOWANCE METHODPERECENTAGE OF RECEIVABLES BASIS
ALLOWANCE METHODPERECENTAGE OF RECEIVABLES BASIS
Date Account Titles Debit Credit
General Journal
Dec. 1 Bad Debts Expense 1,700
Allowance for Doubtful Accounts 1,700
If the trial balance shows Allowance for Doubtful Accounts with a credit balance of $528, an adjusting entry for $,1,700 ($2,228 - $528) is necessary.
Which of the following approaches for bad debtsis referred to as a balance sheet method?A. Percentage of receivables methodB. Direct write-off methodC. Percentage of sales methodD. Both a and b
REVIEW QUESTIONREVIEW QUESTION
Answer: (A) Percentage of receivables method.
STUDY OBJECTIVE 4
DISPOSING OF A/RSTUDY OBJECTIVE 4
DISPOSING OF A/R
Two ways to dispose of A/R
Factoring Credit cardsales
Henderson Furniture factors $600,000 of receivables to Federal Factors, Inc. Federal Factors assesses a 2% service charge.
Date Account Titles Debit Credit
General Journal
Cash 588,000
Service Charge Expense (2% x $600,000) 12,000
Accounts Receivable 600,000
DISPOSING OF A/RFACTORING (SALE) OF RECEIVABLES
DISPOSING OF A/RFACTORING (SALE) OF RECEIVABLES
A factor is a finance company that buys A/R from companies, then collects payments directly from the customers.
Three parties are involved with credit card sales:
The retailer pays the credit card issuer
a fee of 2-6% of the invoice price.
Sales from Visa, MasterCard, and Discover are treated
differently than American Express & Diners Club
Credit card issuer Retailer Customer
CREDIT CARD SALESCREDIT CARD SALES
• Considered cash sales by the retailer.
• Upon receipt of credit card sales slips from a retailer, the bank adds the amount to the seller’s bank balance.
VISA, MASTERCARD, & DISCOVERVISA, MASTERCARD, & DISCOVER
Date Account Titles Debit Credit
General Journal
Cash 970Service Charge Expense 30 Sales 1,000
Barbara Hardy purchases CD’s for her restaurant from Ty Parker Music Co. for $1,000 using her VISA First Bank Card.
First Bank charges a 3% fee.
• Considered credit sales by the retailer.• Conversion into cash does not occur until the
companies remits the net amount to the seller.
AMERICAN EXPRESS & DINERS CLUBAMERICAN EXPRESS & DINERS CLUB
Date Account Titles Debit Credit
General Journal
Accounts Receivable – American Express 285Service Charge Expense 15
Sales 300
Four Seasons for her restaurant from Karen Kerr Music Co. for $1,000 using her VISA First Bank Card. The service fee that First Bank charges is 3%.
• A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.
• The party making the promise is the maker.• The party to receive payment is the payee.
PROMISSORY NOTESPROMISSORY NOTES
• When the life of the note is expressed in terms of days, you need to count the days.
• In counting, the date of issue is omitted but the due date is included.
• Example: The maturity date of a 60-day note dated July 17 is:
STUDY OBJECTIVE 5
MATURITY & INTEREST – NOTES RECEIVABLE
STUDY OBJECTIVE 5
MATURITY & INTEREST – NOTES RECEIVABLE
Term of note 60 days
July (31-17) -14 days
August -31days
Maturity date: September 15
The formula for computing interest on an interest-bearing note is:
The interest rate specified on the note is an annual rate of interest.
Face Valueof Note
Annual Interest
Rate
Timein Terms of
One YearInterestX X =
COMPUTING INTEREST COMPUTING INTEREST
$ 730 X 18% X 120/360 = $ 43.80 $1,000 X 15% X 6/12 = $ 75.00 $2,000 X 12% X 1/1 = $240.00
COMPUTATION OF INTEREST COMPUTATION OF INTEREST
The interest rate specifiedis the annual rate.
Compute the missing amount below:
REVIEW QUESTION REVIEW QUESTION
$450120 days9%?
Total InterestTimeAnnual Interest RateFace Value
I = P x R x T(face value = principal)
$450 = P x .09 x 120/360
P = $15,000
Wilma Company receives a $1,000, 2-month, 12% promissory note from Brent Company to settle an open account.
Date Account Titles Debit Credit
General Journal
May 1 Notes Receivable 1,000 Accounts Receivable – Brent Company 1,000
STUDY OBJECTIVE 6
RECOGNIZING NOTES RECEIVABLESTUDY OBJECTIVE 6
RECOGNIZING NOTES RECEIVABLE
Notes receivable are recorded at FACE VALUE
• N/R are recorded at face value.• Allowance for Doubtful Accounts used to
record estimated uncollectible accounts.• N/R reported on the balance sheet at net
realizable value.
STUDY OBJECTIVE 7
VALUATION OF NOTES RECEIVABLESTUDY OBJECTIVE 7
VALUATION OF NOTES RECEIVABLE
Gross N/R – Allowance = Net Realizable Value
Betty Co. lends Higley Inc. $10,000 on June 1, accepting a 5-month, 9% interest-bearing note.
Betty collects the maturity value of the note from Higley on Nov 1.
STUDY OBJECTIVE 8
DISPOSING OF NOTES RECEIVABLEHONORED NOTE
STUDY OBJECTIVE 8
DISPOSING OF NOTES RECEIVABLEHONORED NOTE
A note is honored when it is paid in full at its maturity date.For an interest-bearing note,
the maturity amount is the face value plus interest.
Date Account Titles Debit Credit
Nov 1 Cash 10,375
Notes Receivable 10,000
Interest Revenue 375
(collection of Higley, Inc. note)
If Betty Co. prepares prepares financial statements on September 30, interest for 4 months, would be accrued.
ACCRUING INTEREST --HONORED NOTE RECEIVABLE
ACCRUING INTEREST --HONORED NOTE RECEIVABLE
Date Account Titles Debit Credit
Sept 30 Interest Receivable ($10,000 x 9% x 4/12) 300
Interest Revenue 300
(accrue 4 month’s interest on Higley, Inc. note)
Interest receivable is a current asset
When interest has been accrued, it is necessary
to credit Interest Receivable at maturity.
ACCRUING INTEREST --HONORED NOTE RECEIVABLE
ACCRUING INTEREST --HONORED NOTE RECEIVABLE
Date Account Titles Debit Credit
Nov 1 Cash 10,375
Notes Receivable 10,000
Interest Receivable 300
Interest Revenue 75
(collection of note at maturity)
A dishonored note is a note that is not paid in full at maturity. Since the payee still has a claim against the maker of the note, the balance in
Notes Receivable is usually transferred to Accounts Receivable.
DISHONOR OFNOTE RECEIVABLE
DISHONOR OFNOTE RECEIVABLE
Date Account Titles Debit Credit
Nov 1 A/R—Higley, Inc. 10,375
Notes Receivable 10,000
Interest Revenue 375
(record dishonor of Higley note)
NOTE: This scenario assumes the note
will eventually be collected.
Date Account Titles Debit Credit
Nov 1 Allowance for doubtful accounts 10,000
Notes Receivable 10,000
(record dishonor of Higley note)
DISHONOR OFNOTE RECEIVABLE
DISHONOR OFNOTE RECEIVABLE
If there is no hope of collection,
The face value eliminated, and the allowance is debited.
Also, no interest would be accrued.
• In the balance sheet, short-term receivables are reported in the current assets section below short-term investments.
• Report both the gross amount of receivables and the allowance for doubtful accounts.
STUDY OBJECTIVE 9
FINANCIAL STATEMENT PRESENTATION & ANALYSIS
STUDY OBJECTIVE 9
FINANCIAL STATEMENT PRESENTATION & ANALYSIS
Accounts receivable $1,200,000
Less: allowance for doubtful accounts (48,000)
Accounts receivable, net $1,152,000
• Financial ratios are computed to evaluate the liquidity of a company’s accounts receivable.
• The accounts receivables turnover ratio is used to assess the liquidity of the receivables.
• The data below is from Cisco Systems:
Net CreditSales
Average Net Receivables
AccountsReceivableTurnover
/ =
A/R TURNOVER RATIOA/R TURNOVER RATIO
$18,878 / ( $1,105 + $1,351)/2 = 15.4 times
• The average collection period in days is a variant of the turnover ratio that makes liquidity even more evident.
• This is done by dividing the turnover ratio into 365 days. • The general rule is that the collection period should not exceed
the credit term period.• Cisco System’s turnover ratio is computed as:
/ =
AVERAGE COLLECTION PERIODAVERAGE COLLECTION PERIOD
Days in yearA/R Turn
Ratio
AverageCollection
Period
365 / 15.4 23.7 days
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