Receivables
CHAPTER
9
PowerPoint Slides to accompany
Fundamental Accounting Principles, 14ce
Prepared by
Joe Pidutti, Durham College
© 2013 McGraw-Hill Ryerson Limited.

Learning Objectives
1.
2.
3.
Describe accounts receivable and how they occur and are recorded. (LO 1 )
Apply the allowance method to account for uncollectible accounts receivable. (LO 2 )
Estimate uncollectible accounts receivable using approaches based on sales and accounts receivable. (LO 3 )
2 © 2013 McGraw-Hill Ryerson Limited.

Learning Objectives
4.
5.
6.
3
Describe and record a short-term note receivable and calculate its maturity date and interest. (LO 4 )
Explain how receivables can be converted to cash before maturity.
(Appendix 9A) (LO 5 )
Calculate accounts receivable turnover and days ’ sales uncollected to analyze liquidity. (Appendix 9B) (LO 6 )
© 2013 McGraw-Hill Ryerson Limited.

Accounts Receivable
•
Arise from credit sales to customers.
•
Often referred to as Trade Receivables.
•
Other receivables include interest receivable, rent receivable, tax refund receivable.
4 © 2013 McGraw-Hill Ryerson Limited. LO 1

Accounts Receivable
Companies selling on account need to:
•
Maintain a separate account for each customer.
•
Account for bad debts.
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Accounts Receivable
Example: TechCom has the following Accounts
Receivable balances at June 30:
General Ledger A/R Subledger
Accounts Receivable RDA Electronics bal. 3,000 bal. 1,000
Control account
CompStore of subledger balances. bal. 2,000
6
Total 3,000
© 2013 McGraw-Hill Ryerson Limited.
LO 1

Accounts Receivable
Example: Credit sale for $950.
Accounts Receivable- CompStore 950
Sales 950
General Ledger A/R Subledger
Accounts Receivable RDA Electronics bal. 3,000
950 bal. 1,000 bal. 3,950
CompStore
7
Control account balances with total of subledger balances. bal. 2,000
950
bal. 2,950
Total 3,950
© 2013 McGraw-Hill Ryerson Limited.
LO 1

Accounts Receivable
Example: Collection of account
Cash 720
Accounts Receivable-RDA 720
General Ledger A/R Subledger
Accounts Receivable RDA Electronics bal. 3,000 bal. 1,000 720
950 720 bal. 280 bal. 3,230
CompStore
Control account balances with total of subledger bal. 2,000
950
8
Total 3,230
© 2013 McGraw-Hill Ryerson Limited.
LO 1

Valuing Accounts Receivable
•
•
Some customers who are granted credit do not pay what they promised.
The accounts of these customers are called uncollectible accounts or bad debts .
9 © 2013 McGraw-Hill Ryerson Limited. LO 1

Valuing Accounts Receivable
Methods for accounting for uncollectible accounts:
1.
Direct method (does not satisfy GAAP)
2.
a) b)
Allowance method (satisfies GAAP)
Income statement approach (percent of sales)
Balance sheet approach (calculates the required balance in AFDA)
10 © 2013 McGraw-Hill Ryerson Limited. LO 2

Allowance Method
•
•
The matching principle requires that bad debts expense be matched and reported in the same period as the sale that generated the receivable.
The allowance method satisfies the matching principle by matching expected bad debts losses (expenses) with revenues that produced the losses.
11 © 2013 McGraw-Hill Ryerson Limited. LO 2

•
•
Recording Estimated Bad Debt
Expense
Adjustments for bad debts are made at the end of the accounting period.
Adjustments use a contra-asset account called Allowance for Doubtful Accounts .
12 © 2013 McGraw-Hill Ryerson Limited. LO 2

Example: The estimated bad debts for TechCom is $1,500.
The period end entry to record bad debts is:
Bad Debts Expense 1,500
Allowance for Doubtful Accounts 1,500
An allowance account is used since we do not know which accounts will be uncollectible.
13 © 2013 McGraw-Hill Ryerson Limited. LO 2

Example: A specific customer ’ s account
(Jack Kent) is considered uncollectible.
The entry to record the write-off is:
Allowance for Doubtful Accounts 520
Accounts Receivable - Jack Kent 520
Note that there is no expense recorded when the account is written off. The estimated expense was previously recorded.
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15
Bad Debts Expense 1,500
Allowance for Doubtful Accounts 1,500
To record estimated bad debts
Allowance for Doubtful Accounts 520
Accounts Receivable - Jack Kent 520
To write off an uncollectible account
Accounts Receivable bal. 20,000
Allow. For Doubtful Accts.
1,500
520 520 bal. 19,480 bal. 980
© 2013 McGraw-Hill Ryerson Limited. LO 2

Accounts Receivable bal. 20,000
Allow. For Doubtful Accts.
1,500
520 520 bal. 19,480 bal. 980
Accounts Receivable
Less: Allowance for Doubtful Accounts
Est. Realizable Accounts Receivable
16 © 2013 McGraw-Hill Ryerson Limited.
Before
Write-off
After
Write-off
$20,000 $19,480
1,500 980
$18,500 $18,500
LO 2

Example: Jack Kent pays his account in full after the account had been written off. Entries are needed to record the reinstatement of the account and the subsequent collection .
The entries are:
Accounts Receivable-Jack Kent 520
Allowance for Doubtful Accounts 520
To reinstate customer ’ s account.
Cash 520
Accounts Receivable-Jack Kent 520
To record collection of account.
17 © 2013 McGraw-Hill Ryerson Limited. LO 2

Estimating Bad Debts Expense
1.
2.
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Percent of Sales Approach
•
•
•
Also referred to as the Income Statement
Approach.
Based on idea that a percentage of a company ’ s credit sales are uncollectible.
The primary focus is on matching bad debts expense with credit sales.
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20
Percent of Sales Approach
Under this approach, bad debts expense is computed as follows:
Current Period Sales x Estimated Bad Debt %
= Estimated Bad Debts Expense
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Percent of Sales Approach
Example: MusicLand has credit sales of $400,000 and estimates 0.6% of those sales will not be collectible. Estimated Bad Debts Expense is calculated as $2,400 ($400,000 x .6%).
The period end adjusting entry would be:
Bad Debts Expense 2,400
Allowance for Doubtful Accounts 2,400
To record estimated bad debts
21 © 2013 McGraw-Hill Ryerson Limited. LO 3

Percent of Accounts Receivable
Approach
•
•
This method assumes that a percentage of
Accounts Receivable is uncollectible.
Using this method, we compute the estimate of the Allowance for Doubtful
Accounts as:
Year-end Accounts Receivable x Est. Bad Debt %
22 © 2013 McGraw-Hill Ryerson Limited. LO 3

Percent of Accounts Receivable
Approach
Bad Debts Expense is computed as:
Estimated adjusted balance in Allowance for Doubtful Accounts
Unadjusted year-end balance in Allowance for Doubtful Accounts
= Estimated Bad Debts Expense
The objective for the entry is to make the Allowance account balance equal to the portion of outstanding Accounts
Receivable estimated to be uncollectible.
23 © 2013 McGraw-Hill Ryerson Limited. LO 3

Aging of Accounts Receivable
Approach
Assumes that the older the Account Receivable the more likely is will become uncollectible.
Steps:
1.
2.
3.
Group accounts based on how much time has passed since they were created.
Estimate rates of uncollectibility for each group.
Apply rate to each group to get the required balance for the Allowance account.
24 © 2013 McGraw-Hill Ryerson Limited. LO 3

Aging of Accounts Receivable
Example: At December 31, the receivables for
DeCor were classified as follows:
DeCor
Schedule of Accounts Receivable by Age
Days Past Due
Current
31-Dec-14
Accounts
Receivable
Balance
$ 37,000
1 - 30
31 - 60
6,500
3,500
61 - 90
Over 90
1,900
1,000
$ 49,900
LO 3
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Aging of Accounts Receivable
Using estimated bad debt percentages, DeCor would calculate the estimated uncollectible amount as follows:
DeCor
Schedule of Accounts Receivable by Age
Days Past Due
31-Dec-14
Accounts Estimated
Receivable
Balance
Bad Debts
Percent
Estimated
Uncollectible
Amount
Current
1 - 30
31 - 60
$ 37,000
6,500

3,500
2%
5%
10%
$ 740

325
350

61 - 90
Over 90
1,900
1,000
25%
40%
475
400
$ 49,900 $ 2,290
26 © 2013 McGraw-Hill Ryerson Limited. LO 3

Aging of Accounts Receivable
DeCor ’ s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290.
Allowance for Doubtful Accounts
Unadj. bal. 200
Adj. bal. 2,290
27 © 2013 McGraw-Hill Ryerson Limited. LO 3

Aging of Accounts Receivable
DeCor ’ s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290. Therefore, the adjusting entry is for:
Allowance for Doubtful Accounts
Unadj. bal. 200
Adj. 2,490
Adj. bal. 2,290
$2,290 + 200 = $2,490.
28 © 2013 McGraw-Hill Ryerson Limited. LO 3

Aging of Accounts Receivable
DeCor ’ s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290. Therefore, the adjusting entry is for:
Allowance for Doubtful Accounts
Unadj. bal. 200
2,490
Adj. bal. 2,290
$2,290 + 200 = $2,490.
Bad Debts Expense 2,490
Allowance for Doubtful Accounts 2,490
To record estimated bad debts
29 © 2013 McGraw-Hill Ryerson Limited. LO 3

Direct Write-off Method
•
Sometimes used as an alternative to the
Allowance method when uncollectible accounts are not material.
•
The loss from an uncollectible account is recorded when it is determined to be uncollectible.
•
This method does not satisfy the principles of prudence and matching.
30 © 2013 McGraw-Hill Ryerson Limited. LO 3

Writing Off a Bad Debt -
Direct Write-off Method
Example: A specific customer ’ s account
(Jack Kent) is considered uncollectible.
The entry to record the write-off is:
Bad Debts Expense 520
Accounts Receivable—Jack Kent 520
31 © 2013 McGraw-Hill Ryerson Limited. LO 3

Mini-Quiz
On October 29, 2014, TC Co. concluded that a customer's
$4,400 account receivable was uncollectible and that the account should be written off. What effect will this write-off have on TC Co.
’ s 2014 net income and balance sheet totals assuming the allowance method is used to account for bad debts?
A)Decrease in net income; no effect on total assets.
B)No effect on net income or on total assets.
C)Decrease in net income; decrease in total assets.
D)Increase in net income; no effect on total assets.
E)No effect on net income; decrease in total assets.
32 © 2013 McGraw-Hill Ryerson Limited.

Mini-Quiz
On October 29, 2014, TC Co. concluded that a customer's
$4,400 account receivable was uncollectible and that the account should be written off. What effect will this write-off have on TC Co.
’ s 2014 net income and balance sheet totals assuming the allowance method is used to account for bad debts?
A)Decrease in net income; no effect on total assets.
B)No effect on net income or on total assets.
C)Decrease in net income; decrease in total assets.
D)Increase in net income; no effect on total assets.
E)No effect on net income; decrease in total assets.
ADA 4,400
33
A/R 4,400
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Short-Term Notes Receivable
Promissory Note
A written promise to pay a specified amount of money either on demand or at a definite future date.
Short-Term Note Receivable
A promissory note that becomes due within
12 months or within the firm ’ s operating cycle.
34 © 2013 McGraw-Hill Ryerson Limited. LO 4

Short-Term Notes Receivable
•
Usually interest bearing.
•
Interest rates are stated on an annual basis.
Interest =
Principal of the interest
X note
Annual rate or I=Prt
Time expressed in years
35 © 2013 McGraw-Hill Ryerson Limited. LO 4

Short-Term Notes Receivable
Example: TechCom receives a $1,000, 90day, 6% promissory note at the time of a sale.
The entry to record the transaction would be:
Notes Receivable 1,000
Sales 1,000
36 © 2013 McGraw-Hill Ryerson Limited. LO 4

Short-Term Notes Receivable
Example: On December 16, TechCom receives a $3,000, 60-day, 6% promissory note and $1,000 cash to settle a $4,000 past due account.
The entry to record the transaction would be:
Cash 1,000
Notes Receivable 3,000
Accounts Receivable 4,000
37 © 2013 McGraw-Hill Ryerson Limited. LO 4

On December 31, 15 days after the note is issued, an accrual for interest earned on the note is made.
The entry to record the accrual would be:
Interest Receivable 7.40
Interest Revenue 7.40
(3,000 x 6% x 15/365)
On February 14, the 60-day note matures.
The entry to record the honouring of the note would be:
Cash 3,029.59
Interest Revenue 22.19
Interest Receivable 7.40
Notes Receivable 3,000.00
(3,000 x 6% x 60/365)= 29.59
38 © 2013 McGraw-Hill Ryerson Limited. LO 4

Short-Term Notes Receivable
•
Sometimes the maker of a note does not pay the note at maturity. This is known as dishonouring the note.
•
The payee should use every legitimate means to collect.
•
If the note was made to replace an AR then it should be removed from Notes
Receivable and reinstated as an Account
Receivable.
39 © 2013 McGraw-Hill Ryerson Limited. LO 4

Review
Explain why the allowance method satisfies the generally accepted principles of prudence and matching.
•
The allowance method ensures that the asset, accounts receivable, and the reported net income are not overstated. In this way it accomplishes the requirements of the prudence principle.
•
The allowance method recognizes the bad debts expense in the same period in which the related credit sales were recognized. In this way it accomplishes the required matching of expenses with the period in which the revenue was recognized.
40 © 2013 McGraw-Hill Ryerson Limited.

Review
Explain how to record the receipt of a note receivable.
•
A note is recorded by entering the total amount borrowed (principal) as a debit to
Notes Receivable and as a credit to the account representing the asset or service exchanged for the note.
41 © 2013 McGraw-Hill Ryerson Limited.

Converting Receivables to Cash
Before Maturity- Appendix 9A
1.
2.
Companies may need the cash.
Companies do not want to be involved in the collection activities.
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Converting Receivables to Cash
Before Maturity- Appendix 9A
1.
2.
Selling them to a factor
Pledging them as loan security.
43 © 2013 McGraw-Hill Ryerson Limited. LO 5

Using the Information
Appendix 9B
The quality (likelihood of collection) and liquidity (speed of collection) of a company ’ s receivables may be assessed by calculating:
1.
2.
Accounts receivable turnover ratio
Days ’ sales uncollected
44 © 2013 McGraw-Hill Ryerson Limited. LO 6

Using the Information
Appendix 9B
Accounts receivable turnover =
Net Sales
Average accounts receivable
Days ’ sales
Uncollected
=
Accounts receivable
Net sales x 365
45 © 2013 McGraw-Hill Ryerson Limited. LO 6

End of Chapter
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