Ms. Cameron
BAT4M
Unit 2: Assets
Chapter 8: Meigs
Receivables
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consist of the money owed to a business
can be created by simply writing out an invoice and delivering, or mailing it to a customer.
As they are usually collected in 30 to 90 days, receivables are:
o considered liquid assets
o found on the balance sheet under current assets.
o key factor in a business’s liquidity --- its ability to pay its bills without additional revenues or selling
fixed assets.

Receivables have three general categories
 Accounts Receivable
 Notes Receivable
 Other
Accounts Receivable and Notes Receivable
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Accounts Receivable
The money owed by customers on account
Money owed by customers for goods or services
provided on credit
Usually collected in 30 days
Very liquid
Appears after Cash or Cash equivalents on the
Balance Sheet
Current Asset


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Notes Receivable
A written promise to pay a specified amount of money
on demand or at a specified time
Used for large amounts for 30 to 90 days,
Usually requires the debtor to pay interest
Very liquid
Appears after Accounts Receivable on the Balance
Sheet
Current Asset or Long-term Assets based on due date
ACCOUNTS RECEIVABLE
i) On June 19, your company sells $2,000 worth of computer parts to Ace computers on credit, terms N/30.
ii) On June 22, Ace Computers returns $500 worth of defective parts.
iii) On July 18, Ace Computers pays you the money owing.
DATE
June 19
PARTICULARS
A/R, Ace Computers
PR
DEBIT
CREDIT
2 000
Sales
2 000
-Sales on account N/30
June 22
Sales Returns and Allowances
500
A/R, Ace Computers
500
-Computer parts returned
July 18
Bank
A/R - Ace Computers
-Collection of Accounts Receivable Ace Computers
1500
1500
Ms. Cameron
BAT4M
Unit 2: Assets
Other Receivables
Other Receivable are amounts owed to a business that do not result from sales transactions.
Examples are:
 Interest Receivable
 Recoverable taxes
 Amounts owing on account from private persons
o A pay advance
o Loan to an executive
Interest Receivable
Recording accounts receivable transactions is a simple process. However, customers do not always pay in full in the
specified time. What happens then? Let’s work through another scenario with Ace Computers.
Ace Computers is both retail and a wholesale operation, they sell merchandise on account to other small retailers.
On May 1, Ace sold $10 000 worth of computers to Cheng Computers, the invoice indicated terms N/30. Like most
retailers, Ace adds interest changes to the balance if the customer does not pay in the specified period.
However, rates can vary, Ace charges 18% per year. Cheng computers will be charged $150 per month ($10 000 x
.18 ÷ 12).
General Journal, Ace Computers
General Journal
Date
Description
May 1
A/R, Cheng Computers
Sales.
Sales on account N/30
June 1
Interest Receivable, Cheng Computers
Interest Revenue
To record interest on amount due
PR
Dr.
10,000
Cr.
10,000
150
150
Transactions related to Accounts Receivable - Bad Debts
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
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Sales on account allow a business to increase their sales.
Businesses realize that they will never collect some of the receivables; this is just a cost of doing business.
A bad debt is an A/R that the business will never collect.
In an accounting system, the entries for uncollectible receivables must be done in accordance with Generally
Accepted Accounting Principles (GAAP).

The accrual basis of accounting requires that you recognize income at the time of the sale.

The Revenue Recognition Principle states revenue must be recognized in the accounting period it is
earned.

The Matching Principle requires that expenses be recognized at the same time as the revenue they support.
Ms. Cameron
BAT4M
Unit 2: Assets

The Principle of Conservatism requires that when choosing between indefinite amounts in asset valuation
we choose the lower range that is least likely to overstate assets and net income.

The Materiality Principle requires accountants to adhere to GAAP except when to do so would be
exorbitantly expensive or difficult, and where there is no real difference if the rules are ignored.
The nonpayment of receivables is a normal cost (expense) of doing business on credit. A business must
account for uncollectible receivables according to GAAP. Remember, expenses must be accounted for in the
same time period as the revenue they support.
How is this going to happen?
A business does not know that a receivable will be uncollectible in the month of the sale. If they did, the business
would not sell to that customer on credit. The Revenue Recognition Principle requires that you must recognize your
income at the time of the sale. While, the Matching Principle requires that an expense be matched to the revenue it
supports.
Even though there is a time lag between when a sale is made on credit and when the business recognizes the
account is a bad debt, that expense should be recognized in the same period as the sale. What a business must do
is match the bad debts to the sales by estimating the amount of bad debts. Bad debts are estimated and
recorded to match revenue and expense in the same time period as the sale.
As you know, the estimate is not a true figure. Ace Computers does not know which actual customer accounts will
be uncollectible. Ace Computers cannot reduce specific customer accounts by the amount of the estimated
Bad Debt Expense. The solution is to credit a separate account with the amount estimated to be
uncollectible.
The accounting entry required creates a contra accounts receivable or valuation account called one of the
following:
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

Allowance for Doubtful Accounts *use this one with Meigs text
Allowance for Bad Debts
Allowance for Uncollectibles
This contra assets account appears on the balance sheet directly after accounts receivable as a deduction for the
accounts receivable account. This process gives a clear picture of the balance sheet value of the accounts
receivable at statement date.
Ace Computers
Balance Sheet (partial)
December 31, 2006
Current Assets
Cash
Accounts Receivable
Less: Allowance for Doubtful Accounts
Merchandise Inventory
$ 39 420.00
$285 175.09
5 088.20
280 086.90*
910 000.00
*$280 086.90 is the Net Realizable Value for the Accounts Receivable: NRV = value of an
asset that can be realized by a company or entity upon the sale of the asset, less the estimated
amount uncollectible.
Ms. Cameron
BAT4M
Unit 2: Assets
METHODS OF ESTIMATING BAD DEBTS:
1. Allowance Method
The allowance method gauges receivables not expected to be collected. A business usually does not know which
accounts receivable they will not collect. The credit manager looks at the amount of receivable still uncollected at
the end of the period and estimates what percentage is uncollectible based upon past experience and current
business conditions.
One method of establishing this percentage is to use the actual write-off amount of the pervious year and
divide it by the total credit sales in the previous year.
To use this method, the credit manager for Ace Computers looks at his last year’s total figures.
1. He looks at the total figure for the accounts that the business was unable to collect last
year, our example below shows $5088.20.
2. Then, he divides this figure by the year’s total sales, $285 175.09.
3.
This gives him the percentage of receivables that the business was unable to collect in
the previous year of 1.78%
Actual total Write-Off 2006
Total Accounts Receivable Sales 2006
Actual Write-0ff % = (5088.20 ÷ 285 175,09)
$
5 088.20
285 175.09
1.78%
4. Now the credit manager multiplies the credit sales reported in the June by the actual
write-off percentage for last year to estimate the bad debt expense for June.
Accounts Receivable Sales in June 2007
Estimated Allowance %
June 2007’s Bad Debt Expense = (26 619.33 x .0178)
$ 26 619.33
.0178
473.82
5. The debt, once it is deemed uncollectible, is written off by the business as an expense.
Ace Computers General Journal, June 2007
General Journal
Date
Description
June 30
Bad Debt Expense
Allowance for Doubtful Accounts
To record accounts receivable estimated to be uncollectible
PR
Dr.
473.82
Cr.
473.82
Writing Off an Uncollectible Accounts Receivable
When the specific (customer) accounts receivable account is deemed uncollectible, the account should no
longer be considered an asset and is removed from the books by:
DR. Allowance for Doubtful Accounts
CR. Accounts Receivable – Client Name
When a particular A/R is later determined uncollectible, this does not represent an additional expense, it merely
confirms our previous estimate. Writing off an A/R does not change the NRV of A/R on the Balance Sheet.
Ms. Cameron
BAT4M
Unit 2: Assets
Example: Ace Computers has decided the J. Grayson account is uncollectible.
Ace Computers
General Journal
Date
Description
Sept 30
Allowance for Doubtful Accounts
Accounts Receivable, J. Grayson
To write off accounts receivable from J. Grayson as
uncollectible.
PR
Dr.
225
Cr.
225
Only balance sheet accounts are affected here. Accounts Receivable and Allowance for Doubtful Accounts. The
NRV of Accounts Receivable stays the same.
Accounts Receivable
Allowance for Doubtful Accounts
Sept 30 Balance
$150 000 Dr Sept 30 Balance
$2 550 Cr
before write-off
before write-off
Sept 30 write-off
225 Cr Sept 30 write-off
225 Dr
149775 Dr
2325 Cr
The NRV of the Accounts Receivable stays the same.
Before write-off: Acc. Rec. Dr. – Allowance for Doubtful Accounts Cr.
150 000 -2 550 = 147 450
After write-off: Acc. Rec. Dr. – Allowance for Doubtful Accounts Cr. 149 775 – 2325 = 147
450
What to do if a previously written-off A/R pays?
J. Grayson calls to say that his financial picture is improving and he is going to pay his debt.
It is a two-step process for Ace Computers to update their accounting records:
Step 1
Reverse entry to write off the account and reinstate customer.
Step 2
Record payment as per usual method.
Ace Computers
General Journal
Date
Description
Nov. 1
Accounts Receivable, J. Grayson
Allowance for Doubtful Accounts
To reinstate J. Grayson account earlier written off
Nov 1
Bank
Accounts Receivable, J. Grayson
Payment of account
PR
Dr.
225
Cr.
225
225
225
Ms. Cameron
BAT4M
Unit 2: Assets
Allowance Method and GAAP
By using the Allowance Method for calculating bad debt, the income statement will comply with the Revenue
Recognition and Matching Principle --- revenue is recognized when earned and matched with the expenses
used to generate that revenue.
The Principle of Conservatism, one of the basic concepts underlying reliable financial records, requires that we
value assets at the most conservative figure we can logically support.
Allowance for Doubtful Accounts enables the accountant to value assets at a conservative figure. It is a
contra asset account with a credit balance. An adjusting entry at the end of each accounting period
offsets the receivables account to give a conservative assessment of the asset that the accountant can logically
support.
EXAMPLE:
Each (month) uncollectible amounts should again be estimated and there should be an adjusting entry to bring
the allowance account to the new estimated amount:
Previous bal: Allowance for Doubtful Accounts= $6000 CR
New Estimate: $11 000 of A/R likely uncollectible
To bring Allowance for D. A to $ 11 000:
DR. Bad Debts Expense (Uncollectible Accounts Expense) $5000
CR. Allowance for Doubtful Accounts
$5000
2. Direct Write-off Method
Uncollectible accounts can be recorded through the allowance method or the direct method.
Some businesses do not recognize uncollectible accounts until the specific receivable is believed to be uncollectible.
The direct-write off method does not attempt to match revenue and expense. Nor does it reflect the
conservatism principle. The accounts receivable will appear on the balance sheet without any reduction for
uncollectibles.
In some circumstances, the direct method is an acceptable form of accounting:
1. The business generates most of its revenue through cash sales.
2. The amount of accounts receivable is minor.
3. The expense from uncollected accounts is trivial.
4. The direct write off method does not have a material effect on the net income. The
Materiality Principle is in effect here.
EXAMPLE:
Let’s look at an example of such a company. Pulscom designs and manufactures plasma screens. They normally
sell to a few large distributors on a cash on delivery (COD) basis. Their product is unique so they are in a position
to dictate the terms. In the past Pulscom has never had a collection problem. They use the direct write off
method. On December 1, Pulscom sells $100 worth of components to another manufacturer on account. By
March 1, the debt becomes uncollectible. It is such a small portion of their sales, Pulscom writes off the debt.
Ms. Cameron
BAT4M
Unit 2: Assets
General Journal
Date
Description
2006
Dec. 1
Accounts Receivable, Moore Parts
Sales
Item # 50082 on account
2007
March 1
Bad Debt Expense
Accounts Receivable, Moore Parts
To write off Moore Parts account
PR
Dr.
Cr.
100
100
100
100
ESTIMATING CREDIT LOSSES
i) Balance Sheet Approach
Called such as this method emphasizes proper B/S valuation of A/R
Estimate is determined by Aging the A/R (classifying according to age and assigning % uncollectible)
Estimated Uncollectible Accounts Receivable
Age Group Total
Not yet due
1-30 days
31-60 days
61-90 days
Over 90 days
TOTALS
$6 400
10 000
13 500
8 200
10 600
%
Uncollectible
2%
5%
6%
7%
10%
Estimated Uncollectible A/R
$128.00
$500.00
810.00
574.00
1060.00
$3 072.00
Therefore at the end of the current month, this company needs to have $3 072 CR Bal in Allowance for
Doubtful Accounts.
Adjusting Entry:
Imagine the balance prior to this estimate in Allowance for D. A. is $2 000.
Ms. Cameron
BAT4M
Unit 2: Assets
Required Entry:
DR Bad Debts Expense (Uncollectible Accounts Expense)
CR Allowance for Doubtful Accounts
-adjusting entry to increase balance to $3 072.
1 072
1 072
ii) Income Statement Approach
Based on past experience, the Bad Debts Expense (Uncollectible Accounts Expense) is estimated as a percent of
net credit sales.
Example:
Company estimates that 2% of Net Credit Sales will be uncollectible based on past experience. This month’s net
credit sales total $150 000.
Adjusting Entry:
*under this method the allowance is CR (and the expense is DR) for the FULL AMOUNT OF THE
ESTIMATE—no consideration is given to any prior balance in Allowance for Doubtful Accounts
DR Bad Debts Expense (or Uncollectible Accounts Expense)
3 000
CR Allowance for Doubtful Accounts
-to record uncollectible accounts expense, 2% of net credit sales
3 000