Receivables and
Inventory
Chapter 6
Classifying Receivables
Accounts Receivable
─Credit terms extended to customers
Notes Receivable
─More formal agreement
─Includes a maker and payee
Other Receivables
─Can include interest receivable, taxes
receivable, and receivables from employees
or officers
Accounting for Notes Receivable
Promissory Notes
Calculate the due date, interest, and
maturity value for the following
promissory note:
Note #1: $5,000, 90-day, 8% promissory
note dated September 28
Uncollectible Receivables
Q. What if a customer does not pay the
balance owed to the company?
A. Companies must recognize an
operating expense for accounts that
are not collectible. It is called Bad
Debt Expense.
Bad Debt Expense
Two Methods:
• Direct Write-Off Method
• Allowance Method
Direct Write-Off Method
Bad Debt Expense is recorded and the
receivable written off when the account
is determined to be worthless
Example: A $6,000 account of Robert
Jennings is deemed to be uncollectible
Let’s record the transaction
Direct Write-Off Method
If payment is collected after the writeoff, the write-off entry is reversed and
the cash collection is recorded
Let’s see how it is done
Direct Write-Off Method
Illustrate the effects on the accounts and financial
statements of the following transactions in the accounts of
Graybeal Co., a hospital supply company that uses the
direct write-off method of accounting for uncollectible
receivables:
Sept 12. Received $9,000 from Dr. Jagers on account and
wrote off the remainder owed of $9,500 as uncollectible.
Dec. 20. Reinstated the account of Dr. Jagers that had been
written off on September 12 and received $9,500 cash as
full payment.
Allowance Method
Required by GAAP for companies with
large accounts receivable.
Estimates the accounts receivable that
will not be collected and records bad
debt expense for this estimate at the
end of each period using an allowance
account.
Allowance Method
Let’s assume that the estimate of
Uncollectible Accounts Receivable at
the end of the period is $5,000
Also assume that the Accounts
Receivable balance at the end of the
period is $80,000
Let’s record the Bad Debt Expense
Write-Offs to the
Allowance Account
When a customer’s account is identified
as uncollectible, it is written off against
the allowance account
Let’s assume that John Smith’s account
for $1,000 is deemed to be uncollectible
Let’s record the transaction
Write-Offs to the
Allowance Account
If payment is collected after the writeoff, the write-off entry is reversed and
the cash collection is recorded
Let’s assume that John Smith decides
to pay the $1,000
Let’s record the transaction
Estimating Uncollectibles
Based on past experiences and
forecasts of the future.
Two common methods:
• Percent of Credit Sales
• Analysis of the Receivables (not in
syllabus)
Estimate Based on
Percent of Credit Sales
Assume that on December 31, 2009, the Allowance for
Doubtful Accounts for ExTone Company has a negative
balance of $250. In addition, ExTone estimates that 1% of
2009 credit sales will be uncollectible. Credit sales for the
year are $500,000
Let’s record the Bad Debt Expense
Allowance Method
Aspen Company, a computer consulting firm, has credit
sales of $5,000,000 during 2002. Aspen estimates it
uncollectible accounts to be 1% of the period’s credit sales.
In early 2003, Aspen decided to write off the $2,800 balance
of an account owed by a customer. Later, the customer paid
the written-off account in full.
1. Determine the amount of the adjustment to provide for
doubtful accounts at the end of 2002, and illustrate the
adjustment’s effect on the accounts and financial
statements.
2. Illustrate the effect on the accounts and financial
statements of the write-off of the account.
3. Illustrate the effect on the accounts and financial
statements of the subsequent collection of the written-off
account.
Inventory Classification for
Merchandisers
In Chapter 4, we learned that merchandise
on hand is called merchandise inventory.
Inventory sold becomes the cost of
merchandise sold
Cost of inventory includes all costs of
ownership (e.g., purchase price,
transportation costs, etc.)
Merchandising Inventories
Size of Merchandise Inventory for Merchandising Businesses
Manufacturing Inventories
Materials Inventory
• Raw material used to make the product
Work-In-Process Inventory
• Cost of partially completed products
Finished Goods Inventory
• Total cost of completed goods: material,
labor, manufacturing overhead
Sales Transactions
When merchandise is sold, companies
need to determine the purchase price of
the merchandise to completely record
the sales transaction.
Remember that COMS has to be
recorded at the same time.
Inventory Purchases
On May 20, sold 1,500 units at $3 each.
Let’s calculate Gross Margin/Ending
Inventory for May (assume BI=0)
MAY
1
6
15
UNITS COST/UNIT
1,000
$2
700
2
800
2
Inventory Purchases
MAY
10
18
24
UNITS COST/UNIT
1
$10
5
12
4
15
What happens when material is purchased
at different prices? How do we determine
COMS? Assume BI=0.
Inventory Cost Flow Assumptions
 If the merchandise can be identified with a
specific purchase, the specific identification
method can be used.
 If specific identification cannot be used and
identical units of merchandise are acquired at
different unit costs, an inventory cost flow
assumption is needed to determine COMS.
Inventory Cost Flow Assumptions
 Three cost flow assumptions can be made:
• First-in, First-out (FIFO)
• Last-in, First-out (LIFO)
• Average Cost
 Method used can significantly affect the
financial statements.
Inventory Purchases
MAY
10
18
24
UNITS COST/UNIT
1
$10
5
12
4
15
On May 26, sold 5 units at $20 each. Let’s
calculate Gross Margin/Ending Inventory
under the three cost flow assumptions
Comparing Methods
(Rising Prices)
METHOD
I/S EFFECT
B/S EFFECT RESULT
FIFO
Lower COGS
Higher gross profit
Inventory shows
replacement cost
Benefit lost
in higher
future costs
LIFO
Higher COGS
Lower gross profit
Lower inventory
values
Matches
current cost
with current
revenue
AVERAGE
Average (middle)
gross profit
Average inventory
value
Compromise
between
LIFO & FIFO
Inventory Cost-Flow Assumptions
The Bike Company
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Beg. Inv.
Purchase
Sales
Purchase
Purchase
Sales
10 units@$91=$910
15 units@$106=$1,590
20 units@$130=$2,600
20 units@115=$2,300
10 units@$119=$1,190
23 units@$150=$3,450
Ending inventory is 12 units. Determine the cost of the
ending inventory using LIFO.