ACCOUNTING FOR RECEIVABLES
STUDY OBJECTIVES
After studying this material, you should understand:
Types of
receivables
Recognition of
A/R
Valuation
of A/R
F/S Presentation & Analysis
TYPES OF RECEIVABLES
Receivables are amounts due from individuals and other companies.
There are three major classes of receivables:
A/R
Owed by customers
on account, from
credit sales, due in
30-60 days.
N/R
Other
Claims supported by a
Loans to company
formal credit instrument. officers, employee
Due in 60-90 days, with advances, refundable
interest.
income taxes.
PRIMARY ACCOUNTING ISSUES
Recognition
Valuation
Disposition
RECOGNIZING A/R
A classic general journal sequence for credit sales.
Date
July 1
Description
A/R—Polo Company
Debit
Credit
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
A/R—Polo Company
(collection of A/R)
18
900
VALUATION OF A/R
• 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
Direct Write-Off
Method
Allowance
Method
DIRECT WRITE-OFF METHOD
• 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.
Bad debts expense
Operating
expense
on the
income
statement
DIRECT WRITE-OFF METHOD
General Journal
Date
Dec. 12
Account Titles
Bad Debts Expense
Accounts Receivable – M.E. Doran
Debit
200
Credit
200
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.
ALLOWANCE 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.
Uncollectible accounts expense = bad debts expense
ALLOWANCE METHOD
RECORDING ESTIMATED UNCOLLECTIBLES
General Journal
Date
Dec. 31
Account Titles
Bad Debts Expense
Allowance for Doubtful Accounts
Debit
12,000
Estimated uncollectibles are debited to Bad Debts
Expense and credited to Allowance for Doubtful
Accounts at the end of each period.
Credit
12,000
ALLOWANCE METHOD
RECORDING A WRITE-OFF
General Journal
Date
Account Titles
Mar. 1
Allowance for Doubtful Accounts
Accounts Receivable - R. A. Ware
Debit
Credit
500
500
Actual uncollectibles are debited to Allowance for
Doubtful Accounts and credited to Accounts Receivable
at the time the specific account is written off.
ALLOWANCE METHOD
RECORDING A RECOVERY
To recover an account that has been written off:
1 reverse the write-off entry.
General Journal
Date
July 1
Account Titles
Debit
Accounts Receivable – R. A. Ware
Allowance for Doubtful Accounts
Credit
500
500
2 record the collection in the usual manner.
General Journal
Date
July 1
Account Titles
Cash
Accounts Receivable
Debit
Credit
500
500
ALLOWANCE METHOD
BASIS FOR ESTIMATING UNCOLLECTIBLES
Two methods of estimating uncollectible accounts
comply with GAAP.
Percentage of Sales
Percentage of Receivables
Matching
Cash Realizable Value
Sales
Bad Debts
Expense
Emphasis on Income
Statement Relationships
Accounts
Receivable
Allowance
for
Doubtful
Accounts
Emphasis on Balance
Sheet Relationships
Uses aging schedule
ALLOWANCE METHOD
PERECENTAGE OF SALES BASIS
• 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.
General Journal
Date
Dec.3 1
Account Titles
Bad Debts Expense
Allowance for Doubtful Accounts
Debit
Credit
8,000
If net credit sales for the year are $800,000, the estimated
bad debts expense is $8,000 (1% X $800,000).
8,000
ALLOWANCE METHOD
PERECENTAGE OF RECEIVABLES BASIS
• 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.
General Journal
Date
Dec. 31
Account Titles
Bad Debts Expense
Allowance for Doubtful Accounts
Debit
Credit
1,700
1,700
If the existing balance in the allowance account is $500 credit, and the
required balance is $2,200, the journal entry to increase the allowance will
be for the difference between the required balance and the existing balance.
If the existing balance in the allowance account is $500 debit,
and the required balance is $2,200, the journal entry to increase
the allowance will be for the sum of the required balance and
existing balance.
General Journal
Date
Dec. 31
Account Titles
Bad Debts Expense
Allowance for Doubtful Accounts
Debit
Credit
2,700
2,700
REVIEW QUESTION
Which of the following approaches for bad debts
is referred to as a balance sheet method?
A. Percentage of receivables method
B. Direct write-off method
C. Percentage of sales method
D. Both a and b
Answer: (A) Percentage of receivables method.
FINANCIAL STATEMENT
PRESENTATION & ANALYSIS
• 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.
Accounts receivable
Less: allowance for doubtful accounts
Accounts receivable, net
$1,200,000
(48,000)
$1,152,000
A/R TURNOVER RATIO
• 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 Credit
Sales
$18,878
/
/
Average
Net Receivables
=
Accounts
Receivable
Turnover
( $1,105 + $1,351)/2 =
15.4 times
AVERAGE COLLECTION PERIOD
• 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:
/
Days in year
365
/
A/R Turn
Ratio
15.4
=
Average
Collection
Period
23.7 days