CHAPTER
9
ACCOUNTING FOR
RECEIVABLES
RECEIVABLES
• The term receivables refers to amounts due from
individuals and other companies; they are claims
expected to be collected in cash.
• Three major classes of receivables are:
i.
Accounts Receivable (due 30 days)
ii.
Notes Receivable (due 30-90 days)
iii. Other Receivables
ACCOUNTS RECEIVABLE
The three primary accounting problems
associated with accounts receivable are:
1. Recognizing accounts receivable.
2. Valuing accounts receivable.
3. Disposing of accounts receivable.
1. RECOGNIZING
ACCOUNTS RECEIVABLE
When a business sells merchandise to a
customer on credit, Accounts Receivable is
debited and Sales is credited.
Date
July 1
Particulars
Debit
Accounts Receivable – Adorable Junior
1,000
Sales
Credit
1,000
1. RECOGNIZING
ACCOUNTS RECEIVABLE (cont.)
When a business receives returned merchandise
previously sold to a customer on credit, Sales
Returns and Allowances is debited and Accounts
Receivable is credited.
Date
July 5
Particulars
Sales Returns and Allowances
Accounts Receivable
Debit
Credit
100
100
1. RECOGNIZING
ACCOUNTS RECEIVABLE (cont.)
When a business collects cash from a
customer for merchandise previously sold
on credit, Cash is debited and Accounts
Receivable is credited.
Date
July 31
Particulars
Cash ($1,000 – $100)
Accounts Receivable
Debit
900
Credit
900
1. RECOGNIZING
ACCOUNTS RECEIVABLE (cont.)
When financing charges are added to a
balance owing, Accounts Receivable is
debited and Interest Revenue is credited.
Date
July 31
Particulars
Accounts Receivable (18% or 1.5% per month on
Debit
13.50
Credit
$900)
Interest Revenue
13.50
2. VALUING
ACCOUNTS RECEIVABLE
• To ensure that receivables are not
overstated, they are stated at their net
realizable value.
• Net realizable value is the net amount
expected to be received in cash and
excludes amounts that the company
estimates it will not be able to collect.
2. VALUING
ACCOUNTS RECEIVABLE (cont.)
• Two methods of accounting for
uncollectible accounts are:
1. Allowance method
2. Direct write-off method
DIRECT WRITE-OFF METHOD
• Under the 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.
• No attempt is made to match bad debts
to sales revenues or to show the net
realizable value of accounts receivable
on the balance sheet.
DIRECT WRITE-OFF METHOD
Periera Company writes off E. Schaefer’s
$200 balance as uncollectible on January
12. When this method is used, Bad Debts
Expense will show only actual losses from
uncollectibles.Why is this a selling operating
expense?
Date
Jan. 12
Particulars
Bad Debt Expense
Accounts Receivable – E. Schaefer
Debit
200
Credit
200
THE ALLOWANCE METHOD
(2 Steps)
• The allowance method is required
when bad debts are deemed to be
material in amount.
• Uncollectible accounts are estimated
and the expense for the uncollectible
accounts is matched against sales in
the same accounting period in which
the sales occurred.
Why?
THE ALLOWANCE METHOD
Step 1
Estimated uncollectible amounts are
debited to Bad Debts Expense and credited
to Allowance for Doubtful Accounts (a
contra asset account) at the end of each
period.
Date
Dec. 31
Particulars
Bad Debts Expense
Allowance for Doubtful Accounts
Debit
24,000
Credit
24,000
ADORABLE JUNIOR GARMET
Balance Sheet (partial)
Current assets
Cash
Accounts receivable
Less: Allowance for doubtful accounts
$ 14,800
$200,000
24,000
Why not just show the
Net Realizable Value,
and omit the rest?
Net Realizable Value
176,000
THE ALLOWANCE METHOD
Step 2
Actual uncollectible accounts are debited
to Allowance for Doubtful Accounts and
credited to Accounts Receivable at the time
the specific account is written off.
Date
Mar. 1
Particulars
Allowance for Doubtful Accounts
Accounts Receivable - Nadeau
Debit
500
Credit
500
THE ALLOWANCE METHOD
When there is recovery of an account that
has been written off:
1. Reverse the entry made to write off the
account
Date
July 1
Particulars
Accounts Receivable – Nadeau
Allowance for Doubtful Accounts
Debit
500
500
2. Record the collection in the usual
manner. Particulars
Date
Debit
July 1
Cash
Accounts Receivable
Credit
Credit
500
500
BASES USED FOR THE
ALLOWANCE METHOD
•
Companies use either of two
methods in the estimation of
uncollectible accounts:
A. Percentage of sales
B. Percentage of aged receivables
•
Both bases are GAAP; the choice is a
management decision.
A. PERCENTAGE OF SALES BASIS
• In the percentage of sales basis, management
establishes what amount of net CREDIT sales are
expected to be uncollectible (usually from past
experience).
• Bad Debt Expense is then determined by applying
the percentage to the sales base of the current
period. The TOTAL amount is charged to Bad Debt.
Observe…
• This basis better matches expenses with revenues.
Date
Dec. 31
Particulars
Bad Debt Expense
Allowance for Doubtful Accounts
Debit
Credit
3,000
3,000
B. PERCENTAGE OF AGED
RECEIVABLES BASIS
•
Under this method, management
estimates what the TOTAL value of bad
debt currently is by applying a
percentage to the actual, existing
accounts receivable balances at the end
of the period.
•
This percentage can be applied to
1. The total receivable balance, or
2. To accounts receivable balances grouped by
age. (see pg 429)
B. PERCENTAGE OF AGED
RECEIVABLES BASIS (cont.)
• The amount of the adjusting entry is the
difference between the required balance
in the allowance account, and the current
balance.
• This basis produces the better estimate
of net realizable value of receivables.
Observe…
Desired
Balance
B. PERCENTAGE OF AGED
RECEIVABLES BASIS (cont.)
• So, if the balance in the Allowance account
is already $2,200, then the adjusting entry
to bring the Allowance up to the present
estimated of Net Realizable Receivables
is…
Date
Dec. 31
Particulars
Bad Debt Expense ($3,245 - $2,200)
Allowance for Doubtful Accounts
Debit
Credit
1,045
1,045
Do the following starting on page 445:
BE9-1 to 6
E9-2
E9-3
P9-2A
P9-3A
3. DISPOSING OF
ACCOUNTS RECEIVABLE
To accelerate the receipt of cash from
receivables, owners frequently:
1. sell to a factor, such as a finance
company or a bank, and
2. make credit card sales.
3. DISPOSING OF
ACCOUNTS RECEIVABLE (cont.)
• A factor buys receivables from businesses
for a fee and collects the payments
directly from customers.
• Credit cards are frequently used by retailers
who wish to avoid the paperwork of issuing
credit.
• Retailers can receive cash more quickly from
the credit card issuer.
CREDIT CARD SALES
• Three parties are involved when credit
cards are used in making retail sales:
1. the credit card issuer,
2. the retailer, and
3. the customer.
• The retailer pays the credit card issuer
a
percentage fee of the invoice
price for its services.
BANK CARD SALES
• Sales resulting from the use of VISA and
MasterCard are considered cash sales
by the retailer.
• These cards are issued by banks.
• Upon receipt of credit card sales slips
from a retailer, the bank immediately
adds the amount to the
seller’s bank balance.
BANK CARD SALES
• We purchase a CDs for our restaurant
from Karen Kerr Music Co. for $1,000
using our Royal Bank VISA card.
• The service fee that the Royal charges is
3.5 percent.
What other account does this
resemble?
Date
July 31
Particulars
Cash
Credit Card Expense ($1,000 x 3.5%)
Sales
Debit
Credit
965
35
1,000
NOTES RECEIVABLE
• 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 whom
payment is made is
called the payee.
IMPORTANT TERMS
• Interest rate
• The cost of borrowing others’ money. It is an
expense, not the repayment of debt
• Face Value
• The price of a note or bond, written on the actual
contract (note)
• Term
• The length of the note or bond before it is due
• Maturity
• When the note/bond’s face value is due, along
with any outstanding interest
IMPORTANT TERMS
• Interest is always calculated as follows:
Interest
Expense
=
Face
Value
X
Interest
Rate
NOTES RECEIVABLE
• We now will look at the following three
procedures for dealing with notes:
– Acquisition
– Adjustment/valuation
– Disposal/termination
• Note: these three steps are similar to
many things we will look at this
semester. Best to look for trends and
processes.
RECOGNIZING NOTES RECEIVABLE
Acquisition
Wilma Company receives a $1,000, 6%
promissory note, due in two months (July 1)
from Brent Company to settle an open
account.
Date
May 1
Particulars
Notes Receivable
Accounts Receivable – Brent
Company
Debit
1,000
Credit
1,000
VALUING NOTES RECEIVABLE
• Like accounts receivable, short-term
notes receivable are reported at their
net realizable value.
• The notes receivable
allowance account is
Allowance for
Doubtful Notes.
VALUING NOTES RECEIVABLE
Adjustment/Valuation
• If Wilma company adjusts monthly, the
journal entry will look like this:
Date
May 31
Particulars
Interest Receivable
Interest Revenue
Debit
Credit
5
5
• If they do not, not entry will be recorded
until the note matures and pays
interest.
VALUING NOTES RECEIVABLE
Disposal/Termination
• If Wilma company adjusts monthly, the
journal entry will look like this:
Date
May 31
Particulars
Cash
Interest Receivable
Interest Revenue
Notes Receivable
Debit
1,010
Credit
5
5
1,000
VALUING NOTES RECEIVABLE
Disposal/Termination
• If Wilma company does NOT adjust
monthly, the journal entry will look like
this:
Date
May 31
Particulars
Cash
Interest Receivable
Notes Receivable
Debit
1,010
Credit
10
1,000
DISHONOUR OF NOTES RECEIVABLE
• A dishonoured note is a note that is not paid in
full at maturity.
• A dishonoured note receivable is no longer
negotiable.
• Since the payee still has a claim against the
maker of the note, the balance in Notes
Receivable is usually transferred to Accounts
Receivable.
Date
Sept. 30
Particulars
Accounts Receivabl
Notes Receivable
Interest Revenue
Debit
1,010
Credit
1,000
10
BALANCE SHEET PRESENTATION
OF RECEIVABLES
• Both the gross amount of receivables
and the allowance for doubtful
accounts should be reported.
• Why?
USING THE INFORMATION IN THE
FINANCIAL STATEMENTS
• Financial ratios are calculated to evaluate
the short-term liquidity of a company.
• Recall these ratios:
1. current ratio,
2. acid test (quick) ratio,
3. receivables turnover, and the
4. A/R collection period (in days).
Do the following starting on page 449:
BE9-7 to 12
P9-8A
P9-10A