Module 5
Accounts Receivable and
Accounts Payable
Learning Objectives
Explain Accounts Receivable.
Describe and illustrate entries for the recording of Accounts Receivable.
Illustrate and practice allowance methods to value Accounts Receivable.
Illustrate and practice estimation methods to value Accounts Receivable.
Percent of sales
Percent of Accounts Receivable
Illustrate and practice the Direct write off method.
Describe accounting for short term Notes Receivables.
Discuss converting Short Term notes to cash before maturity
Discuss AR Turnover and Days Sales uncollected Ratios.
Explain Accounts Payable.
Describe classification of Liabilities.
Run an SAP demonstration.
Practice making receivable and payable entries in SAP.
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Introductory Accounting
Accounts Receivable
Arise from credit sales to
customers.
Often referred to as Trade
Receivables.
Other receivables include interest
receivable, rent receivable, tax
refund receivable.
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Introductory Accounting
Accounts Receivable
Companies selling on
account need to:
Maintain a separate
account for each customer.
Account for bad debts.
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Introductory Accounting
Accounts Receivable
Example: Sample has the following Accounts
Receivable balances at June 30:
General Ledger
Accounts Receivable
bal. 5,000
Control account
balances with
total of subledger
balances.
A/R Subledger
Jones Co
bal. 2,000
Store ABC
bal. 3,000
Total 5,000
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Introductory Accounting
Accounts Receivable
Example: Credit sale for $550
Accounts Receivable- Store ABC
Sales
General Ledger
Accounts Receivable
bal. 5,000
550
550
A/R Subledger
Jones Co
bal. 2,000
550
bal. 5,550
Store ABC
Control account
balances with
total of subledger
balances.
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bal. 3,000
550
bal. 3,550
Total 5,550
Introductory Accounting
Accounts Receivable
Example: Collection of account
Cash
850
Accounts Receivable-Jones Co
General Ledger
Accounts Receivable
bal. 5,000
550
A/R Subledger
Jones Co
bal. 2,000
850
850
bal. 1,150
bal. 4,700
Store ABC
Control account
balances with
total of subledger
balances.
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bal. 3,000
550
bal. 3,550
Total 4,700
Introductory Accounting
850
Non-Bank Credit Cards
Retailers often accept non-bank credit
cards.
The retailers mail the receipts and await
payment from the credit card company.
These companies charge the retailer a
fee and deduct it from the amount owing.
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Introductory Accounting
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.
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Introductory Accounting
Valuing Accounts Receivable
Methods for accounting for
uncollectible accounts:
• Allowance method (satisfies
GAAP)
• Direct method (does not satisfy
GAAP)
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Introductory Accounting
Allowance Method
Satisfies matching principle by matching expected bad
debts losses (expenses) with revenues that produced the
losses.
Adjustments for bad debts are made at the end of the
accounting period.
Adjustments use a contra-asset account called Allowance
for Doubtful Accounts.
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Introductory Accounting
Recording Estimated Bad Debt Expense — Allowance
Method
Example: The estimated bad debts for Jones
Co is $1,000.
• The period end entry to record bad debts is:
Bad Debts Expense
1,000
Allowance for Doubtful Accounts 1,000
An allowance account is used since we do not
know which accounts will be uncollectible.
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Introductory Accounting
Writing Off a Bad Debt —
Allowance Method
Example: A specific customer’s account (Ron
Trent) is considered uncollectible.
• The entry to record the write-off is:
Allowance for Doubtful Accounts
Accounts Receivable — Ron Trent
880
880
Note that there is no expense recorded when
the account is written off. The estimated
expense was previously recorded.
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Introductory Accounting
General Ledger Balances
Bad Debts Expense
Allowance for Doubtful Accounts
To record estimated bad debts
Allowance for Doubtful Accounts
Accounts Receivable — Ron Trent
To write off an uncollectible account
Accounts Receivable
880
880
1,000
880
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1,000
Allow. For Doubtful Accts.
bal. 18,000
bal. 17,120
1,000
880
bal. 120
Introductory Accounting
Realizable Value Before and After Write-off
Accounts Receivable
Allow. For Doubtful Accts.
bal. 18,000
1,000
880
bal. 17,120
880
bal. 120
Before
Write-off
Accounts Receivable
Less: Allowance for Doubtful Accounts
Est. Realizable Accounts Receivable
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After
Write-off
$18,000
$17,120
1,000
120
$17,000
$17,000
Introductory Accounting
Recovery of a Bad DebtAllowance Method
Example: Ron Trent 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-Ron Trent
880
Allowance for Doubtful Accounts
880
To reinstate customer’s account.
Cash
Accounts Receivable-Ron Trent
To record collection of account.
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880
880
Introductory Accounting
Estimating Bad Debt Expense
Acceptable Methods:
- Percent of Sales Approach
- Accounts Receivable Approach
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Introductory Accounting
Percent of Sales Approach
Also referred to as the Income Statement
Approach.
Based on idea that a percentage of a
company’s sales are uncollectible.
The primary focus is on estimating bad
debts expense for the income statement.
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Introductory Accounting
Percent of Sales Approach
Under this approach, bad debts
expense is computed as follows:
Current Period Credit Sales
x Estimated Bad Debt %
= Estimated Bad Debts Expense
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Introductory Accounting
Percent of Sales Approach
Example: BCD Company has sales of $500,000 and
estimates 0.5% of those sales will not be collectible.
Estimated Bad Debts Expense is calculated as $2,500
($500,000 x .5%).
The period end adjusting entry would be:
Bad Debts Expense
2,500
Allowance for Doubtful Accounts
2,500
To record estimated bad debts
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Introductory Accounting
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 Bad Debt %
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Introductory Accounting
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.
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Introductory Accounting
Aging of Accounts Receivable Approach
Assumes that the older the Account Receivable
the more likely is will become uncollectible.
Steps:
1. Group accounts based on how much time has
passed since they were created.
2. Estimate rates of uncollectibility for each group.
3. Apply rate to each group to get the required balance
for the Allowance account.
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Introductory Accounting
Aging of Accounts Receivable
Example: At December 31, the receivables for
ABC Co were classified as follows:
ABC Co
Schedule of Accounts Receivable by Age
31-Dec-06
Days Past Due
Current
1 - 30
31 - 60
61 - 90
Over 90
Accounts
Receivable
Balance
$
$
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40,000
5,000
4,000
2,000
1,000
52,000
Introductory Accounting
Aging of Accounts Receivable
Using estimated bad debt percentages, ABC Co
would calculate the estimated uncollectible
amount as follows:
ABC Co
Schedule of Accounts Receivable by Age
31-Dec-06
Accounts
Estimated
Estimated
Receivable
Bad Debts
Uncollectible
Days Past Due
Balance
Percent
Amount
Current
1 - 30
31 - 60
61 - 90
Over 90
$
$
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40,000
5,000
4,000
2,000
1,000
52,000
2% $
5%
10%
25%
40%
$
Introductory Accounting
800
250
400
500
400
2,350
Aging of Accounts Receivable
ABC Co’s unadjusted balance in
the allowance account is a debit Allowance for Doubtful Accounts
Unadj. bal. 700
of $700. The previous
3,050
computation shows the desired
Adj. bal. 2,350
balance is $2,350; therefore, the
adjusting entry is for $2,350 +
700 = $3,050.
Bad Debts Expense
3,050
Allowance for Doubtful Accounts
To record estimated bad debts
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Introductory Accounting
3,050
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
matching and conservatism.
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Introductory Accounting
Writing Off a Bad Debt — Direct Write-off Method
Example: A specific customer’s account
(Ron Trent) is considered uncollectible.
The entry to record the write-off is:
Bad Debts Expense
450
Accounts Receivable—Ron Trent
450
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Introductory Accounting
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.
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Introductory Accounting
Short-Term Notes Receivable
Usually interest bearing.
Interest rates are stated on an annual basis.
Interest is calculated as follows:
Principal
Interest = of the
note
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X
Annual
interest
rate
X
Time
expressed
in years
Introductory Accounting
Short-Term Notes Receivable
Example: Sample Co receives a $2,000, 90-day,
10% promissory note at the time of a sale.
The entry to record the transaction would be:
Notes Receivable
Sales
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2,000
2,000
Introductory Accounting
Short-Term Notes Receivable
Example: On December 1, Sample Co receives a $5,000,
60-day, 10% promissory note and $1,000 cash to settle a
$6,000 past-due account.
The entry to record the transaction would be:
Cash
Notes Receivable
Accounts Receivable
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1,000
5,000
6,000
Introductory Accounting
Short-Term Notes Receivable
On December 31, 30 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
Interest Revenue
(5,000 x 10% x 30/365)
41.10
41.10
On January 30, the 60-day note matures.
The entry to record the honouring of the note would be:
Cash
5,082.20
Interest Revenue
Interest Receivable
Notes Receivable
(5,000 x 10% x 60/365)= 82.20
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41.10
41.10
5,000.00
Introductory Accounting
Converting Receivables to Cash Before Maturity
Receivables are sometimes
converted into cash before
maturity since:
• Companies may need the cash.
• Companies do not want to be involved
in the collection activities.
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Introductory Accounting
Converting Receivables to Cash Before Maturity
Conversion of
receivables into cash is
accomplished by either:
• Selling them to a factor
• Pledging them as loan security.
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Introductory Accounting
Ratios
The quality (likelihood of collection) and
liquidity (speed of collection) of a company’s
receivables may be assessed by calculating:
• 1. Accounts receivable turnover ratio
• 2. Days’ sales uncollected
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Introductory Accounting
Ratios
Accounts receivable turnover =
Net Credit Sales
Average accounts receivable
Days’ sales
Uncollected
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=
Average accounts receivable
Net sales
Introductory Accounting
x 365
Accounts Payable
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Introductory Accounting
Accounts Payable
Arise from credit purchases from vendors
Often referred to as Trade Payables.
Companies buying on account need to
Maintain a separate account for each vendor.
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Introductory Accounting
Accounts Payable
Example: Sample has the following Accounts
Payable balances at March 30:
General Ledger
Accounts Payable
bal. 5,000
A/P Subledger
Jones Co
bal. 2,000
Store ABC
Control account
balances with
total of subledger
balances.
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bal. 3,000
Total 5,000
Introductory Accounting
Accounts Payable
Example: Credit purchase for $550.
Purchases
550
Accounts payable A/P
- Store
ABC
550
General Ledger
Subledger
Accounts Payable
bal. 5,000
Jones Co
bal. 2,000
550
bal. 5,550
Store ABC
Control account
balances with
total of subledger
balances.
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bal. 3,000
550
bal. 3,550
Total 5,550
Introductory Accounting
Accounts Payable
Example: Payment on account
Accounts Payable - Jones Co
Cash
General Ledger
850
A/R Subledger
Accounts Payable
Jones Co
bal. 5,000
850
850
550
bal. 2,000
850
bal. 1,150
bal. 4,700
Store ABC
Control account
balances with
total of subledger
balances.
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bal. 3,000
550
bal. 3,550
Total 4,700
Introductory Accounting
Liabilities
A future payment of assets or services that a company is presently
obligated to make as a result of past transactions or events.
Present obligation to make a future payment.
Result from past transactions.
May be classified as current or long-term.
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Introductory Accounting
Current vs. Long-Term Liabilities
Current Liabilities
• Are due within one year or within the next
operating cycle, whichever is longer.
• Are settled using current assets or by
creating other current liabilities.
Long-Term Liabilities
• Do not require payment within the longer of
one year or an operating cycle.
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Introductory Accounting
Current vs. Long-Term Liabilities
Current liability
Balance
sheet
date
Long-term liability
1 year or
operating
cycle
Examples:
•Accounts payable
•Unearned revenues
•Wages payable
•Current portion of
notes payable
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•Bonds payable
•Lease obligations
•Long-term portion of notes payable
Introductory Accounting
Known (Determinable) Liabilities
Are obligations that have little uncertainty
and are set by agreements, contracts, or
laws.
Examples:
•Accounts payable
•Unearned revenues
•Payroll taxes
•Sales taxes
•Notes payable
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Introductory Accounting
Short-Term Notes Payable
A current obligation in the form of
a written promissory note.
• May be issued:
• To replace an account payable
• When obtaining a bank loan
• To purchase merchandise or other
assets
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Introductory Accounting
Short-Term Notes Payable: Example
On November 30, a note is used to replace a $5,000 overdue
account payable that does not bear interest. The customer
agrees to pay $1,000 cash and sign a 60-day, 10% note to
replace the account payable.
The customer’s entry to record this transaction would be:
Accounts payable
Cash
Notes payable
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5,000
1,000
4,000
Introductory Accounting
On December 31, the customer’s year end, an
interest accrual is made.
The customer’s entry to record this accrual would
be:
Interest expense
33.97
Interest payable
33.97
$4,000 x 10% x 31/365
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Introductory Accounting
On January 30, the note’s due date, the note and
interest is paid in full.
The customer’s entry to record this would be:
Notes payable
Interest payable
Interest expense
Cash
4,000.00
33.97
31.78
4,065.75
$4,000 x 10% x 29/365 = $37.78
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Introductory Accounting