W09 Chapter 8

TYPES OF RECEIVABLES
Receivables refers to amounts due from individuals and companies. They are
claims expected to be collected in cash.
Receivables are frequently classified as:
-Accounts receivable
-Notes receivable
-Other receivables

NOTES RECEIVABLE
Notes receivable
-Represent claims for which formal instruments of credit are issued as evidence of
debt.
-Credit instrument normally requires payment of interest and extends for time
periods of 60-90 days or longer.

OTHER RECEIVABLES
Other receivables
-Non-trade including interest receivable, loans to company officers, advances to
employees, and income taxes refundable.
-Generally reported as separate items on the balance sheet.

RECOGNIZING ACCOUNTS RECEIVABLE

-Service organizations record accounts receivable when a service has been
provided on account.
-Merchandisers record accounts receivable at the point of sale of merchandise on
account.
-Receivables may be reduced by sales discounts and/or sales returns.
Account Titles and Dr. Cr.
Explanation

Accounts Receivable 100

   Sales 100

CREDIT LOSSES
ACCOUNTING FOR UNCOLLECTIBLE
ACCOUNTS
Methods to account for uncollectible accounts:
-Direct Write-Off Method
-Allowance Method
DIRECT WRITE-OFF METHOD
-Bad debts losses are not estimated.
-No allowance account is used.
-Accounts are written off when determined uncollectible as follows:

-Bad debt expense will show only the actual losses from uncollectibles.
-Bad debt expense is often recorded in a period different from the period in which
the revenue was recorded.
-No attempt is made to match bad debt expense to sales revenues in the income
statement or to show accounts receivable in the balance sheet at the amount
actually expected to be received.
-Unless bad debts losses are insignificant, the direct write-off method is not
acceptable for financial reporting purposes.

EFFECTS OF DIRECT WRITE-OFF METHOD

ALLOWANCE METHOD
The allowance method:
-Provides better matching on the income statement and ensures that receivables are
stated at their cash (net) realizable value.
-Cash (net) realizable value is the net amount expected to be received in cash; it
excludes amounts that the company estimates it will not collect.
-Receivables are therefore reduced by estimated uncollectible receivables on the
balance sheet through use of the allowance method.
1
Required for financial reporting purposes when bad debts are material in amount.
Uncollectible accounts receivable are estimated and matched against revenues in
the same accounting period in which the revenues occurred.
2
Estimated uncollectibles are recorded as an increase (a debit) to Bad Debt Expense
and an increase (a credit) to Allowance for Doubtful Accounts (a contra asset
account) through an adjusting entry at the end of each period.
Date Account Titles and Explanation Dr. Cr.

Bad debt expense XX

Allowance for doubtful accounts XX

3
Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited
to Accounts Receivable at the time the specific account is written off as
uncollectible.
DATE ACCOUNT TITLES AND EXPLANATION DR. CR.

Allowance for doubtful accounts XX

Accounts receivable XX
RECORDING ESTIMATED UNCOLLECTIBLES
Hampton Furniture has credit sales of $1,200,000, of which $200,000 remains
uncollected. The credit manager estimates $12,000 will prove uncollectible.
DATE ACCOUNT TITLES AND EXPLANATION DR.

Bad Debt Expense 12,000

Allowance for Doubtful Accounts

RECORDING ESTIMATED UNCOLLECTIBLES

HAMPTON FURNITURE
Balance Sheet (partial)
Current assets

Cash $14,800

Accounts receivable $200,000

Less: Allowance for doubtful accounts 12,000 188,000

Merchandise inventory 310,000

Prepaid expense 25,000

Total current assets $537,800

CASH (NET) REALIZABLE VALUE

-Is the net amount expected to be collected in cash.
-Excludes amounts the company estimates it will not collect.
-Keeps receivables from being overstated on the balance sheet.

WRITE-OFF OF AN UNCOLLECTIBLE
ACCOUNT
The vice president of finance authorizes a write-off of $500 owed by R.A. Ware.
Date Account Titles and Explanation Dr. Cr.

Allowance for Doubtful Account 500

 Accounts Receivable-Ware 500

WRITE-OFF OF AN UNCOLLECTIBLE
ACCOUNT

Date Account Titles and Explanation Dr. Cr.

Allowance for Doubtful Accounts 500

Allowance Receivable-Ware 500

Accounts Receivable
Jan 1 Bal   200,000 Mar 1
  500
Mar 1 Bal   199,500

Allowance for Doubtful Accounts

Mar 1 Jan 1 Bal   12,000
  500
Mar 1 Bal   11,500

WRITE-OFF OF AN UNCOLLECTIBLE
ACCOUNT
Before Write-off
Current assets

Cash $14,800

Accounts receivable $200,000

Less: Allowance for doubtful accounts 12,000 188,000

Cash Realizable Value

After Write-off
Current assets

Cash $14,800
Accounts receivable $199,500

Less: Allowance for doubtful accounts 11,500 188,000

Cash Realizable Value

ESTIMATING THE ALLOWANCE FOR

DOUBTFUL ACCOUNTS

Not Yet Number of Days Past Due

Customer Total
Due 1-30 31-60 61-90 Over 90
T.E. Adert $600   $300   $200 $100
R.C. Bortz 300 $300        
B.A. Carl 450   200 $250    
O.L. Diker 700 500     200  
T.O. Ebbet 600     300   300
Others 36,950 26,200 5,200 2,450 1,600 1,500
  $39,600 $27,000 $5,700 $3,000 $2,000 $1,900
Estimated
percentage   2% 4% 10% 20% 40%
uncollectible
Total estimated
uncollectible $2,228 $540 $228 $300 $400 $760
accounts

PERCENTAGE OF RECEIVABLES BASIS

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.

Dec. 1 Bad Debt Expense 1700

Allowance for Doubtful Accounts 1700

(To adjust allowance account to total estimated uncollectibles)

If management estimates that $2,228 of accounts receivable will not be collected and the
trial balance shows Allowance for Doubtful Accounts with a credit balance of $528, an
adjusting entry for $1700($2228- $528) is necessary.
 ESTIMATING THE ALLOWANCE

Allowance for Doubtful Accounts

500 2728
2,228

Date Account Titles and Explanation Dr. Cr.

Bad Debt Expense 2728

Allowance for Doubtful Accounts 2728

ACCOUNTING FOR BAD DEBTS

Under the allowance method of accounting for bad debts.
-Actual uncollectibles are debited to Allowance for Doubtful Accounts  and credited
to Accounts Receivable  .
-Estimated uncollectibles are debited to Bad Debt Expense  and credited to Allowance for
Doubtful Accounts  .
-Writing off an account Does Not Change  receivables reported on the balance sheet.

NOTES RECEIVABLE

When the life of the note is expressed in terms of months, the due date is found by
counting the months from the date of issue.
Example:
The maturity date of a 3-month note dated May 31 is August 31.
DETERMINING THE MATURITY DATE
-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:
Term of note 60 days

July 31 - 17 14

August 31 45

Maturity date, September 15

COMPUTATION OF INTEREST
Interest rate specified on a note is an annual rate of interest.

Terms of Note Interest Computation

  Face x Rate x Time = Interest
$730, 18%, 120 days $730 x 18 % x 120/360 = $43.8$
$1,000, 15%, 6 month $1,000 x 15 % x 6/12 = $75$
$2,000, 12%, 1 year $2,000 x 12 % x 1/1 = $240.00

Helpful hint: The interest rate specified is the annual rate and a 360 day year is
assumed.
 RECOGNIZING NOTES RECEIVABLE
GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.

May 1 Notes Receivable 1,000

Accounts Receivable 1,000

(To record acceptance of Brent Company note)

Wilma Company receives a $1,000, 2-month, 12% promissory note from Brent
Company to settle an open account.

VALUING NOTES RECEIVABLE

Notes receivable are reported at their cash realizable value.
The notes receivable allowance account is Allowance for Doubtful Accounts.
Notes receivable $18,000

Less: Allowance for doubtful accounts 1,200

Cash realizable value $16800

HONOR OF NOTES RECEIVABLE

-A note is honored when it is paid in full at maturity.
-Interest revenue is usually recorded when the note is paid. However, when
financial statements are prepared, unrecorded interest revenue that has been earned
on notes receivable must be accrued.
Date Account Titles and Explanation Dr. Cr.

Nov. 1 Cash 10,375

Notes Receivable 10,000

Interest Revenue 375

BALANCE SHEET PRESENTATION
-Short-term receivables are reported in the current asset section of the balance
sheet below short-term investments.
-Both the gross amount of receivables and the allowance for doubtful accounts
should be reported.
-Notes receivable are listed before accounts receivable because notes are more
easily converted to cash.

INCOME STATEMENT PRESENTATION

-Bad Debt Expense is reported as a selling expense in the income statement.
Interest Revenue is shown under Other Revenues and Gains in the nonoperating
section of the income statement.
-If a company has significant risk of uncollectible accounts or other problems with
receivables the situation must be discussed in the notes to the financial statements.

DETERMINE TO WHOM CREDIT SHOULD BE

EXTENDED
-Risky customers might be required to provide letters of credit or bank guarantees.
-Risky customers might be required to pay cash on delivery (COD).
-Ask potential customers for references from banks and suppliers and check the
references.
-Periodically check financial health of continuing customers.

ESTABLISH A PAYMENT PERIOD

-Determine a required payment period and communicate that policy to customers.
-Make sure company's payment period is consistent with that of competitors.

MONITOR COLLECTIONS
-Prepare accounts receivable aging schedule at least monthly.
-Pursue problem accounts with phone calls, letters, and legal action if necessary.
RECEIVABLES TURNOVER RATIO
The receivables turnover ratio
Measures the number of times, on average, receivables are collected during the
period.

-In a popular variant of the receivables turnover ratio, the turnover ratio, the
turnover ratio is converted into an average collection period in terms of days.
-This is computed by dividing the receivables turnover ratio into 365 days.
The collection period should not greatly exceed the credit term period.

THREE REASONS FOR THE SALE OF

RECEIVABLES
-The first is their size. In recent years, companies often have provided financing to
purchasers of their goods. Many major companies have created companies that accept
responsibility for accounts receivable financing (i.e., General Motors has General Motors
Acceptance Corporation — GMAC, Ford has Ford Motor Credit Corp — FMCC).
-Second, receivables may be sold because they may be the only reasonable source of cash.
-A final reason for selling receivables is that billing and collection are often time-consuming
and costly.
NATIONAL CREDIT CARD SALES

Date Account Titles and Explanation Dr. Cr.

Cash 970

Service Charge Expense 30

Sales 1,000

(To record Visa credit card sales)

SALE OF RECEIVABLES
A common way to accelerate receivables collection is a sale to a factor. A factor is
a finance company or a bank that buys receivables from businesses for a fee and
then collects the payments directly from the customers.
If a company usually sells its receivables, the service charge expense is recorded as
a selling expense. However, if receivables are sold infrequently the fee may be
reported under Other Expenses and Losses in the income statement.

Account Titles and Dr. Cr.

Explanation

Cash 588,000

Service Charge Expense 12,000

Accounts Receivable 600,000