Accounting for
Receivables
Chapter 8
Receivables
Includes all money claims against other
entities, including people, business firms,
and other organization.
 Are usually a significant portion of the
total current assets.

Types of Receivables

Accounts receivable

Results from the sale of
merchandise on credit and
expected to be collected within
a relatively short period, such
as 30 or 60 days.
Types of Receivable

Notes receivable:



Are amounts that
customer owe, for
which a formal written
instrument of credit
has been issued.
Are usually used for
credit periods of more
than sixty days.
May be used to settle
a customer’s accounts
receivable
Uncollectible receivables





When allowing customers to purchase on credit, we
run the risk of nonpayment.
Many retail businesses may shift the risk of
uncollectible to other companies. Allow only VISA or
Mastercard.
Companies may also sell their receivables to other
companies. Usually companies issue their own credit
cards.
Regardless of the care used in granting credit and the
collection procedures used, a part of the credit sales
will not be collectible.
Bad debts expenses – operating expense recorded
from the uncollectible receivables.
Two methods

Allowance method


Required by generally
accepted accounting
principles
(GAAP)
Estimates the accounts
receivable that will not be
collected and records bad
debt expense for this
estimate at the end of each
accounting period.

Direct write off
method


No estimate of
uncollectible
Write off as
deemed
uncollectible
Allowance Method
We create a CONTRA ASSET ACCOUNT
called Allowance for Bad Debts. It
increases with a credit.
 Record the total estimate that has not been
written off.
 Entry is considered an adjusting entry.

Allowance method

Allowance account
Records the estimate uncollectible
 Credit to increase


Bad Debts Expense
Records the annual estimated uncollectible
 Uncollectible account expense

Adjusting Entry
Suppose that accounts receivable have a
Balance of $105,000 and it is estimated that
$4,000 will go bad. Record the adjusting entry under the
allowance method.
Account
Bad Debts Expense
Allowance for Bad Debts
Debit
Credit
$4,000
$4,000
Net Realizable Value
Net Realizable Value =
Accounts receivable balance – Allowance for bad debts
What is really expected to be collected!
Write offs to the Allowance
Account
Once that we determine that a particular
customer will be not collectible, we write
off the account.
 The write off consists of reducing the
allowance account by the amount of the
write off and removing the uncollectible
account from accounts receivable.

Example 2

Suppose that J Mays account with a balance of
$1,200 is uncollectible.
Account
Allowance for Bad Debts
Accounts Receivable
Debit
Credit
$1,200
$1,200
Estimating Uncollectibles
The allowance method estimates bad
debts expense at the end of the period.
 Estimate of uncollectibles at the end of a
fiscal period is based on past experience
and forecasts of the future.
 Two methods are used:

Estimated based on percentage of sales
 Analysis of accounts receivable.

Estimated Based on Sales

We assume that a percentage of credit
sales will go bad and record that as the
adjusting entry.
Example 3:


Suppose that credit sales for the period were $800,000
of which 1% is expected to be uncollectible. Record the
entry.
$800,000 x 1% = $ 8,000
Account
Bad Debts Expense
Allowance for Bad Debts
Debit
Credit
$8,000
$8,000
Example 4

Suppose that the company expects 3%
of credit sales to go uncollected. A
review of the trial balance shows:
Sales $1,000,000 of which 45% are cash
sales.
 Accounts receivable has a balance of
$70,000.
 Allowance for bad debts has credit balance
of $2,000.

Example 4
Credit sales are
Estimate is
$1,000,000 x 55% =
$550,000 x 3% =
$550,000
$16,500
Allowance for Bad Debts
Debit
Credit
$2,000 balance
$16,500 should be balance
Example 4

As a result of the credit balance in the
Allowance account,


We will record the entry not for $16,500 but $14,500
( $16,500 - $2,000).
Account
Bad Debts Expenses
Allowance for bad debts
Debit
Credit
$14,500
$14,500
Example 5
Suppose that the company expects 3%
of credit sales to go uncollected. A
review of the trial balance shows:
 Sales $1,000,000 of which 45% are cash
sales.
Accounts receivable has a balance of
$70,000.
 Allowance for bad debts has debit
balance of $2,000.

Example 5
Credit sales are
Estimate is
$1,000,000 x 55% =
$550,000 x 3% =
$550,000
$16,500
Allowance for Bad Debts
Debit
Credit
$2,000 balance
$16,500 should be balance
Example 4

As a result of the credit balance in the
Allowance account,


We will record the entry not for $16,500 but $18,500
( $16,500 + $2,000).
Account
Bad Debts Expense
Allowance for bad debts
Debit
Credit
$18,500
$18,500
Rule
When the Allowance Account at the
end of the year:
 Has a debit balance  we
underestimated the bad debts last
period.
 Has a credit balance  we
overestimated the bad debts last
period.

Notes on Allowance method

If allowance account has prior balance
then at end of year should equal
estimated uncollectible
Analysis of Receivables


Actually looking at
each individual
account and
determining
probability of collect
ability
Aging of receivables
Aging Schedule
Age Interval Balance
Not past due
1 –30
31 – 60
61 – 90
91 – 180
181 – 365
Over 365
Total
$75,000
4,000
3,100
1,900
1,200
800
300
86,300
Percent
Amount
2%
5%
10%
20%
30%
50%
80%
$1,500
200
310
380
360
400
240
3,390
Entry
Date
Account
May Bad debts Expense
21
Allowance account
Debit
Credit
3,390
3,390
Direct write off Method
There is no estimated uncollectible
 No allowance account
 Only when specific customer goes bad
will it be written off to the expense
account

Direct Write off

Example 5: Suppose that Haby’s account goes
bad with a balance of $8,000
Date
Account
May 21 Bad debts Expense
Accounts receivable
Debit
Credit
$8,000
$8,000
Reinstatement of write offs


Allowance method
Example 6: Suppose Habys pays the amount
due.
Date
Account
May 21 Accounts receivable
Allowance account
Debit
Credit
$8,000
$8,000
Reinstatement of write offs

Direct Write off method
Date
Account
May 21 Accounts receivable
Bad Debts expense
Debit
Credit
$8,000
$8,000
Notes Receivable
Characteristics





Promissory note – is a written
promise to pay a sum of
money on demand or at a
definite time.
Payee – the person to whom
the note is payable to
Maker – one making the note
and owing the money
Due date – when the note is
due
Maturity value = principal +
interest
Sample Note
I, Chris owe Odalys $10,000 payable in 60 days
plus 12% interest.
Signed Chris
May 1, 2007
Principal
Maker
Payee
Interest rate
Time
Computation of Due Date


The length of time that the note is
open is usually stated in days or
months.
Use 360 day year for easy of
computation in class but in real life
we use 365 day year.
Before
calculators
easier to use
360 days to
make
calculations
Example 7

Suppose that a note is issued on May 1st
for 60 days when is the note due.
Days in note
Days in month note is issued
Day note is issued
Days available in month
Days for next month
Days in next month June
Note due on June 30th
60 days
31 days
1
30
30
30
Example 8

Use information in the sample note
Computation of Interest
Principal X Rate X Time = Interest
Amount
due on
note
Interest
rate on
note
Amount
due
Days in note
360 days
Computation of Interest
Example: Suppose that face or principal
of note is $30,000, interest rate is 10%
for 60 days.
 Principal X Rate X Time = Interest
 $30,000 X 10% X 60/360 = $500
 Maturity value = Principal + Interest

= $30,000 + $500

= $30, 500

Example 8

Suppose that a note for $20,000 with
12% is issued on June 5 for 90 days.
Compute the due date, interest, and
maturity value of the note.
Accounting for Notes
Receivables

A customer may use a note to replace an
account receivable.

This causes the creation of a note
receivable and the removal of the
outstanding accounts receivable.
Example 9

Suppose that the account for Mister is past
due. Mister converts the receivable to a note
for 60 days at 10%. The balance is $6,000.
Date
Account
P
Debit
Credit
r
May
21
Notes receivable
Accounts receivable
$6,000
$6,000
Example 9

Mister pays amount
due on the date.
Date
Account
P
Debit
Credit
r
Cash
$6,100
Notes receivable
$6,000
Interest revenue
$100
Note that is paid on due date is said to be HONORED
Dishonored Notes
When the maker does not pay the
maturity value on the due date, the note
is said to be DISHONORED
 At this time, the note ceases to exist, the
maturity value of the note is reported
again as an Accounts Receivable.
 We include the interest computed as
income earned but not yet received.

Example 9

Date
Suppose that the account for Mister is past due. Mister
converts the receivable to a note for 60 days at 10%. The
balance is $6,000. On the due date, the note becomes
dishonored
Account
Accounts receivable
Pr
Debit
Credit
$6,100
Notes receivable
$6,000
Interest revenue
$100
Notice that the difference is that we debit accounts receivables
instead of cash.