CHAPTER 9 STUDY OBJECTIVES
1. IDENTIFY AND DISTINGUISH AMONG THE
DIFFERENT TYPES OF RECEIVABLES.
2. SHOW HOW ACCOUNTS RECEIVABLE ARE
RECOGNIZED IN THE ACCOUNTS.
3. DESCRIBE AND USE THE METHODS AND
BASES USED TO VALUE ACCOUNTS
RECEIVABLE.
4. DETERMINE THE ENTRIES TO RECORD THE
DISPOSITION OF ACCOUNTS RECEIVABLE.
5. DETERMINE THE INTEREST ON NOTES
RECEIVABLE.
6. SHOW HOW NOTES RECEIVABLE ARE
RECOGNIZED IN THE ACCOUNTS.
7. DEMONSTRATE HOW NOTES RECEIVABLE ARE
VALUED.
8. DETERMINE THE ENTRIES TO RECORD THE
DISPOSITION OF NOTES RECEIVABLE.
9. ILLUSTRATE THE STATEMENT PRESENTATION
OF RECEIVABLES.
1. TYPES OF RECEIVABLES
Receivables refer to amounts due from individuals and other companies that are
expected to be collected in cash.
Receivables are classified as either:

Accounts receivable, are amounts owed by customers on account.
These receivables are expected to be collected within 30 days or so.

Notes receivable represent claims for which formal instruments of credit
are issued as evidence of the debt. The debtor normally is required to pay
interest and the time period may extend for 30 to 90 days or longer. Notes
and accounts receivable that result from sales transactions are often
called trade receivables.

Other receivables include nontrade receivables such as GST
recoverable, interest receivable, loans to company officers, advances to
employees, and recoverable income taxes.
2. RECOGNIZING (RECORDING) ACCOUNTS RECEIVABLE
Accounts receivable are recognized when merchandise is sold on account, as
explained in Chapter 5.
Recognizing accounts receivable also occurs when a company sells
merchandise and a customer uses the company’s own credit card.
Credit card sales result in a debit to Accounts Receivable and a credit to
Sales.
If customers fail to pay within a specified period (usually 30 days), the seller adds
interest. The interest is debited to Accounts Receivable and credited to Interest
Revenue.
3. VALUING ACCOUNTS RECEIVABLE
Valuing receivables involves reporting them at their net realizable value. Net
realizable value is the net amount expected to be received in cash.
Credit losses are considered a normal and necessary risk of doing business on a
credit basis. Credit losses may be recognized under the direct write-off method or
by the allowance method.
a)
The Direct Write-Off Method
When an account is determined to be uncollectible, the loss is charged to Bad
Debts Expense.
As a result, bad debts expense sill show only actual losses from uncollectible
accounts.
Bad debt expense is often recorded in a period other than the period in which the
revenue was recorded. No attempt is made to match bad debts expense with
sales revenues or to show the net realizable value of the accounts receivable.
The direct write-off method may be used for financial reporting purposes only
when bad debts are insignificant.
b)
The Allowance Method
The allowance method is required for financial reporting purposes when bad
debts are material in amount. Under this method:
Uncollectible accounts receivable are estimated. This estimate is treated as an
expense and is matched against sales in the same accounting period in which
the sales occurred.
Estimated uncollectibles are debited to Bad Debts Expense and credited to
Allowance for Doubtful Accounts through an adjusting entry at the end of each
period.
Actual uncollectibles are debited to Allowance for Doubtful Accounts and
credited to Accounts Receivable at the time the specific account is written off.
Occasionally, a company collects from a customer after the account has been
written off as uncollectible.
The entry made in writing off the account is reversed to reinstate the customer’s
account.
The collection is journalized in the usual manner.
Two bases are used to determine the amount of the expected uncollectibles:
percentage of sales and percentage of receivables.
a)
Under the percentage of sales basis, management establishes a
percentage relationship between the amount of credit sales and expected
losses from uncollectible accounts. The percentage is based on past
experience and anticipated credit policy, and is usually applied either to
total credit sales or net credit sales of the current year.
This basis of estimating uncollectibles emphasizes the matching of
expenses with revenues (income statement viewpoint).
When the adjusting entry is made, the existing balance in the Allowance
for Doubtful Accounts is disregarded.
b)
Under the percentage of receivables basis, management establishes a
percentage relationship between the amount of receivables and expected
losses from uncollectible accounts. This percentage can be applied to total
receivables or to groupings of receivables by age.
This basis produces a better estimate of net realizable value (balance
sheet viewpoint).
An aging schedule is often used to determine the required balance in the
allowance account at each balance sheet date.
When the adjusting entry is made, the amount of bad debt expense is the
difference between the required balance and the existing balance in the
allowance account.
4.
DISPOSING OF ACCOUNTS RECEIVABLE
In the normal course of business, accounts receivable are collected in cash and
removed from the books.
Companies frequently sell accounts receivable for cash, to another company,
called a factor. Receivables may be sold because:
a) they are the only reasonable source of cash.
b) billing and collection are often time-consuming and costly.
A credit card sale occurs when a company accepts credit cards such as VISA,
Mastercard, and American Express.
VISA and Mastercard sales are considered cash sales because the bank
immediately adds the amount of the sale to the seller’s bank balance less a
service charge fee.
American Express (and other nonbank credit) card sales are reported as credit
sales because the retailer must await collection from American Express. The
amount collected is net of a service charge fee.
Debit cards allow customers to spend only what is in their bank account. When
a debit card sale occurs, the bank deducts the amount from the customer’s bank
account and transfers it to the retailer’s bank account, less a service fee. The
journal entries are like ones done for bank credit cards, but the expense account
is called Debit Card Expense.
Rather than sell its receivables a company may borrow money from a bank,
using the receivables as collateral.
5. INTEREST ON NOTES RECEIVABLE
A promissory note is a written promise to pay a specified amount of money on
demand or at a definite time. Promissory notes may be used:
a) When individuals and companies lend or borrow money.
b) When the amount of the transaction and the credit period exceed
normal limits.
c)
In settlement of an open account
Notes receivable gives the holder a stronger legal claim to assets than accounts
receivable and can be readily sold to another party.
The formula for calculating interest is Principal value X Annual interest rate X
Time in terms of one year. Time is the number of months within the period (not to
exceed a year) divided by 12.
6. RECOGNIZING NOTES RECEIVABLE
Recognition occurs when the note is received. The note is recorded at its face
value by debiting Notes Receivable and crediting Accounts Receivable. No
interest revenue is recorded when the note is received. Interest will be earned
and recorded as time passes.
7. VALUING NOTES RECEIVABLE
Notes receivable are reporting at their net realizable value, just like accounts
receivable are valued.
The computations and estimations involved in determining net realizable value
and bad debt expense for notes are similar to accounts receivable. The notes
receivable allowance account is Allowance for Doubtful Accounts.
8. DISPOSING OF NOTES RECEIVABLE
A note is honoured when it is paid in full at its maturity date. If interest has been
accrued prior to maturity, Interest Receivable is credited for the accrued interest
at maturity.
A dishonoured note is a note that is not paid in full at maturity. The entry to
record the dishonour of a note depends on whether eventual collection is
expected. If the debtor is expected to pay, an Accounts Receivable is recognized
for the face value of the note plus accrued interest. If there is no hope of
collection, no interest revenue is recorded and the face value of the note should
be written off by debiting Allowance for Doubtful Notes account.
Notes receivable may be sold to a third party prior to maturity. The seller will
receive the maturity value of the note, less a discount fee. This process is called
discounting notes receivable.
9. STATEMENT PRESENTATION OF RECEIVABLES
Each of the major types of receivables should be identified in the balance sheet
or in the notes to the financial statements.
Short-term receivables are reported below temporary investments within the
current asset section of the balance sheet. Both the gross amount of receivables
and allowance for doubtful accounts should be reported.
In the income statement:
(a) Bad Debts Expense, Credit Card Expense and Debit Card Expense are
reported as selling expenses in the Operating Expense section
(b) Interest Revenue is shown under Other Revenues and Gains.